Housing Risk and Its Influence on House Price: An Expected Utility Approach

Abstract

House price is affected by households’ expectation of future house price trend and volatility, where the expected volatility of housing capital return, indicated by variance, is defined as the housing market risk. Theoretically, risk element cannot be directly inserted in the standard housing models because most of the models are built on the underlying assumption of certainty. Extending the life-cycle model to a two-asset expected utility case with uncertainty, we show house price is affected by housing market risk premium, which is a function of households’ risk-aversion coefficient, real housing wealth, and expected housing volatility. Empirical analysis relying on China’s 2001–2018 provincial housing panel data supports the theoretical innovation. Despite the empirical results show that the effect of housing market risk on house price is tiny, simulations suggest that the consideration of risk is quite helpful in analyzing and predicting the long-run house price equilibriums.