Natural Expectations and Home Equity Extraction

Transcription

1 Natural Expectations and Home Equity Extraction R. Pancrazi 1 M. Pietrunti 2 1 University of Warwick 2 Banca d Italia and Toulouse School of Economics 5 June 2014 Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 1 / 35

2 Introduction U.S. Households Leverage and House Price boom Some Facts: : Households debt to income from 66 to more than 100 percent : House price index increased by 65 percent Home equity extraction: 58bn in 1990, 103bn in 1999, 400bn in : Extracted Equity relative to income from 5 percent to 10 percent. Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 2 / 35

3 Households Leverage Introduction Understanding Households Leverage process and House Price: Source of leverage cycle [Geanakoplos, 2010] Relationship between house price and consumption [Campbell and Cocco, 2007] Concentration of Risk in financial system [Khandani et al., 2013] Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 3 / 35

4 Our Explanation Introduction Explanation for the increased households leverage Small variations in Long-Run House Price Expectations leads to Large changes of desired Home Equity Extraction Two ingredients: Availability of Home Equity Extraction Natural Expectations regarding future House Price Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 4 / 35

5 Home Equity Extraction Introduction Housing wealth becoming a liquid asset Home Equity Line of Credit (HELOC): loan in which lender lend a maximum amount within an agreed period (term), where the collateral is the borrower s equity in her house. Ms. Kennedy says that with the $70,000 from the cash-out refinancing she got this year, she is investing in the stock market and considering buying another home for investment purposes. Her current home surged in value by $134,000 over the past 16 years. Now, her goal is to turn her cash-out windfall into $250,000 over the next 10 to 15 years. I just didn t want to let $70,000 sit in my home Wall Street Journal, July 26, 2001 Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 5 / 35

6 Home Equity Extraction Introduction Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 6 / 35

7 Natural Expectations Introduction House Price Characterized by Short-Run Momentum and Long-Run Mean-Reversion Using too simple models, agents fail to account for Long-Run Mean-Reversion [Natural Expectations, Fuster et al., 2010, 2012] After a positive House-Price shock, agents overestimate Long-Run House Price Large incentive to borrow today to smooth future housing wealth Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 7 / 35

8 Introduction Support of Natural Expectations and House Price Owners overestimate their house values by 4 to 16% [Goodman and Ittner (1992),Case and Shiller (2003), Shiller (2008), Benitez-Silva et al. (2009)] Recent Crisis: accurate Short-run expectation, abnormal Long-term (10 years) expectations [Case, Shiller, Thompson (2012)] Homeowners with higher test scores less likely to overestimate the value of their house [Agurwal and Mazumder (2013)] Financial Experts ignored the Long-Run Mear Reversion of house price [Our Evidence] Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 8 / 35

9 Learn from History... Introduction If [pushing house prices up] are being driven up by extrapolative expectations then a bubble may be forming, and that is clearly bad. The latter case could put a large number of households in a vulnerable position that takes a long time to recover from. Governor Mark Carney, BoE, 11 March 2014 Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 9 / 35

10 Main Findings: Empirical Introduction Two Stylized facts: 1 Home Equity Extraction tightly related to House Price 2 Less Educated Households have extracted more equity than More Educated Households Empirical Analysis of House Price: 1 House Price displays Short-Run Momentum and Long-Run Mean-Reversion 2 Natural models that ignore Long-Run mean reversion have equivalent in-sample fit to more complicated models. Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 10 / 35

11 Introduction Main Findings: Theoretical Quantify the role of Long-run house price forecast in households debt: 1 Model of Households and banks in a Home Equity Loan market 2 Consider a large range of possible expectations of future house price Results: 1 Small increase in naturalness induces large increase in household indebtedness during a boom 2 During boost more natural households display a severe deleverage process 3 In welfare terms, natural households are severely penalized during a boom-bust period 4 Differente degrees of naturalness match the observed heterogeneity of home equity extraction across education categories Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 11 / 35

12 Outline Stylized Facts about Home Equity Extraction 1 Introduction 2 Stylized Facts about Home Equity Extraction 3 Natural House Price Expectations 4 Financial Expert Forecasts 5 Model 6 Results Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 12 / 35

13 Stylized Facts about Home Equity Extraction Evidence 1: Home Equity Extraction and House Price Figure : Revolving Home Equity Loans and house prices in the U.S. Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 13 / 35

14 Stylized Facts about Home Equity Extraction Evidence 2: Home Equity Extraction and Education SCF, 2001 and 2004 he i = β 0 + βeduc i + γx i + ɛ i, (1) (2) (3) HELOC-to-income Edu=1 (a) 0.766*** 0.802*** 0.730*** Edu= *** *** *** Edu= *** ** Edu= Edu= ** ** Age *** *** *** Age *** *** *** Life-cycle= ** *** *** Life-cycle= *** *** *** Life-cycle= Life-cycle= *** *** *** Life-cycle= log(house-to-mortgage) 0.119*** 0.082*** log(net worth) *** Observations R Weighted average life-cycle coefficient (b) Demeaned Edu=1 [(a)+(b)] Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 14 / 35

15 Outline Natural House Price Expectations 1 Introduction 2 Stylized Facts about Home Equity Extraction 3 Natural House Price Expectations 4 Financial Expert Forecasts 5 Model 6 Results Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 15 / 35

16 U.S. House Prices Natural House Price Expectations Figure : Real U.S. House Price index (upper panel) and its growth rate (lower panel) Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 16 / 35

17 Natural Expectations Natural House Price Expectations (1 Φ p (L)) r t = µ + ε t Two Natural models: 1 Intuitive Expectations: p=1. 2 Finite Memory: Estimating p using only T =100 observations Two Sophisticated models: 1 BIC Expectations: p=5. 2 AIC Expectations: p=16. Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 17 / 35

18 Natural House Price Expectations Natural Expectations and Forecasts Note: Blue = Intuitive Expectations. Purple = Finite Memory. Red = BIC. Green= AIC. Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 18 / 35

19 Natural House Price Expectations Natural Expectations and Forecasts Intuitive (p = 1) finite memory (p = 6) BIC (p = 5) AIC (p = 16) RMSE R R 2 (adj.) log-likelhood p-value LR test (against AR1) One period Ahead Forecast Confidence Bands (95%) [1.90; 1.97] [2.31;2.82] [2.18; 2.44] [2.18; 2.48] Long-Run Persistence (LRP) Confidence Bands (95%) [10.3; 31.4] [6.4; 59.5] [8.6; 28.9] [5.1; 17.7] Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 19 / 35

20 Outline Financial Expert Forecasts 1 Introduction 2 Stylized Facts about Home Equity Extraction 3 Natural House Price Expectations 4 Financial Expert Forecasts 5 Model 6 Results Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 20 / 35

21 Financial Expert Forecasts Financial Expert Forecast Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 21 / 35

22 Financial Expert Forecasts Financial Expert Forecast Forecasts t + q q = t = Table : Nominal Growth Forecasted House Price Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 22 / 35

23 Outline Model 1 Introduction 2 Stylized Facts about Home Equity Extraction 3 Natural House Price Expectations 4 Financial Expert Forecasts 5 Model 6 Results Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 23 / 35

24 Elements of the model Model T -period economy Two agents: Household and Bank Two goods: consumption and housing Household owns house and pledge it as collateral Recursive formulation - Backward induction solution Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 24 / 35

25 Model Household Problem max {ct,d t,def t} T t=0 E 0 T β t u(c t, h), t=0 def t =0: def t =1: c t + (1 + r t 1 )d t 1 = y + d t c t + γp t h = y Forecasting House Price: p t+1 = p t ( 1 + r h t+1 ), r h t+1 = Θ p (L)r h t + σε t+1,, Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 25 / 35

26 Bank Problem Model (r t 1 i t 1 )d t 1 + δe t π t+1 (r t, d t, p t+1 ) if the household does not default (and did not default in the past) max d t π t (r t 1, d t 1, p t ) = κp t h (1 + i t 1 )d t 1 if the household defaults (but did not in the past) 0 if the household defaulted in the past. Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 26 / 35

27 Model Strategy Fix T = 10 Fix a given path for house price similar as in Simulated house price (black solid line), actual Shiller index from 2001 to 2010 (dotted line).. Vary the expectation specifications (50 processes from more to less natural) Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 27 / 35

28 Expectations Model r h t+1 = µ(1 θ 1 θ 2 ) + θ 1 r h t + θ 2 r h t 1 + σε t+1, Set µ = 0 (as the average between 1953 and 2006) Set θ 1 =0.6. (All the specification have same 1-period ahead forecast) Vary θ 2 to span a large set of Long-Run Persistence (from 1.4 to 4.5, covering the confidence band for annual data) Vary σ to fix the same unconditional variance Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 28 / 35

29 Model Expectations Least natural AR1 Most natural Figure : IRFs and CIRFs for selected processes Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 29 / 35

30 Calibration Model Parameter Value Description β=δ 0.98 Discount rate for household and banks h 1.5 Housing stock η 2 CRRA coefficient y 1 Income per year γ 0.05 Rental rate as a fraction of house value κ 0.2 Collateral value for the bank as a fraction of house value Table : Calibration of structural parameters Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 30 / 35

31 Outline Results 1 Introduction 2 Stylized Facts about Home Equity Extraction 3 Natural House Price Expectations 4 Financial Expert Forecasts 5 Model 6 Results Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 31 / 35

32 Boom and Bust Dynamics Results 0.55 Debt LTV ratio 8 Boom Bust Consumption Debt Service Ratio Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 32 / 35

33 Whole Period Results Process Debt-to-income LTV ratio DSR ratio Consumption equivalent Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 33 / 35

34 Naturalness and Education Results Naturaleness data model Education category 0.2 Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 34 / 35

35 Conclusion Results Long-run House Price Forecast of House Price and Households Leverage Agents (household and Financial Experts) likely to ignore House-Price Long-Run Mean Revertion Amplification mechanism through the lens of macroeconomic model of Home Equity Extraction Pancrazi, Pietrunti (Warwick, BdI-TSE) Natural Home Equity Extraction Paris 35 / 35