The impacts of housing derivatives trading on the housing market

Abstract

Housing is the largest asset class in the world. However, in contrast to other major asset classes, including stocks and bonds, it does not have a well-developed derivatives market. In fact, housing derivatives can provide many benefits and help to overcome the main drawbacks of direct housing investments, including their lack of liquidity, lumpiness, high transaction costs, and short sale constraints. Proposals to develop housing derivatives markets have long been discussed in the academic literature. During the last two decades, several housing derivatives products have been developed and traded, especially in the U.K. and in the U.S. Although housing derivatives markets are still at an early stage of their development, several other initiatives are now being undertaken to enhance well-functioning markets. While developing these markets, it is crucially important to understand their potential impact. This thesis therefore studies the effects of housing derivatives trading on the housing market. The first chapter provides an overview of how the housing derivatives markets have developed, and outlines what have been the main obstacles to the growth of these markets. This chapter also analyses the hedging demand of homeowners in order to motivate the following chapters. The second chapter focuses on the housing and hedging decisions of financially constrained and unconstrained households. The effects of housing derivatives trading on households’ housing decisions are investigated in the intensive and the extensive margins of home ownership. The third chapter studies the effects of housing derivatives trading on house price stability. The analysis indicates that housing derivatives trading affects house price stability through three channels: by enabling households to disentangle their housing consumption decisions from their investment decisions, by allowing short-selling, and by attracting an additional set of traders (speculators), who use housing derivatives for portfolio diversication purposes.