Working Paper: NBER ID: w10955
Authors: Hanno Lustig; Stijn Van Nieuwerburgh
Abstract: In a model with housing collateral, a decrease in house prices reduces the collateral value of housing, increases household exposure to idiosyncratic risk, and increases the conditional market price of risk. This collateral mechanism can quantitatively replicate the conditional and the cross-sectional variation in risk premia on stocks for reasonable parameter values. The increase of the conditional equity premium and Sharpe ratio when collateral is scarce in the model matches the increase observed in US data. The model also generates a return spread of value firms over growth firms of the magnitude observed in the data, because the term structure of consumption strip risk premia is downward sloping.
Keywords: No keywords provided
JEL Codes: G0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Decrease in house prices (R31) | Reduction in collateral value of housing (R31) |
| Reduction in collateral value of housing (R31) | Increase in household exposure to idiosyncratic risk (G59) |
| Reduction in collateral value of housing (R31) | Increase in conditional market price of risk (G19) |
| Decrease in house prices (R31) | Increase in household exposure to idiosyncratic risk (G59) |
| Decrease in house prices (R31) | Increase in conditional market price of risk (G19) |
| Collateral mechanism (D47) | Differences in expected returns between equity and risk-free assets (G12) |
| Increase in conditional equity premium (G19) | Correlation with periods of scarce collateral (E44) |
| Model (C52) | Generates return spread of value firms over growth firms (G19) |