By the end of 2005, the value of residential homes equaled $21.6 trillion, comparable in size to the $17.0 trillion in domestic equities and $25.3 in fixed income assets...and it is very risky
... house price volatility has been considerable. Quarterly changes of more than 8% (annualized) have been observed in US aggregate house prices in one out of ten quarters in the last 20 years. This masks the severe volatility in regional prices such as the 28% (annualized) increase in Seattle house prices in the late 1990s and the 12% (annualized) decrease in Houston house prices in the mid 1980s ....
One of the easiest ways to insure against price risk is with a futures contract. For example, Suppose a farmer sells a futures contract on the crop that he plants, and the crop price decreases. He loses money on his crop but makes money on his futures contract, and vice-versa. The futures contract transfers price risk from the farmer to the speculator who buys the contract.
So it would seem that home owners would want to insure themselves against price risk by selling futures contracts on the S&P/Case-Schiller(r) local real estate price indices, which began trading on the Chicago Mercantile Exchange in 2006.
Not so fast. Chris Hinkelmann and Steve Swidler (article) find that
Even at a local level, price changes may vary dramatically from one part of the metropolitan area to another. ... In one county zip code, the median home price fell 36.50% for the year, while in another county zip code, the median home price rose 38%. ... With such a wide dispersion of home price appreciation, it is unlikely that any single city index can effectively hedge real estate portfolios from the same metropolitan area.
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