Portfolio Implications of Homeownership - Hedging Housing Risk in Urban and Peripheral Sweden

Abstract: This paper investigates the investment implications of the housing consumption choice in a mean-variance framework using quarterly time series ranging from the first quarter 1986 to the last quarter 2005. We analyze the investment portfolio of the Swedish household on a quarterly horizon containing general stocks, real estate stocks, T-bills, government bonds and housing. Furthermore, this paper assesses the potential benefit from hedging the household’s housing investment, firstly with general and real estate stocks and secondly with a tradable national real estate price index. In addition, this paper investigates the repercussions of house location throughout the analysis. In contrast to earlier papers investigating hedging of housing risk we use fully comparable time series for the assets in the mean-variance optimization. We find the optimal housing investment to be increasing with desired risk in the span of 3%-151% of net wealth for urban households and practically zero for non-urban households regardless of desired risk level. Observed values of housing investment to net wealth indicate that many Swedish households suffer from an overinvestment in housing, which entails additional risk. Hedging this risk with general and real estate stocks gives limited results. We do however find larger potential gains from hedging with a tradable national housing price index. The gains from hedging are higher the more severe the overinvestment is. The scope for reducing risk through hedging is also higher for the urban households, whether hedging with stocks or with the housing price index.