Natural Expectations and Home Equity Extraction
Transcription
Natural Expectations and Home Equity Extraction
Natural Expectations and Home Equity Extraction Roberto Pancrazi1 1 2 Mario Pietrunti 2 University of Warwick Toulouse School of Economics, Banca d’Italia 4 December 2013 AMSE Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 1 / 32 Introduction Motivation Spark of the recent global crisis: the 2007 mortgage crisis Boom of collateralized credit market related to housing wealth Economy excessively exposed to an unpredicted fall of house prices Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 2 / 32 Introduction Why Economy Excessively Exposed? 1 Financial instruments made housing a liquid asset 2 House prices are hard to predict These two ingredients likely to create distortions Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 3 / 32 Introduction Intuition Simply from the Permanent Income Hyphotesis... Households have biased expectations about future housing prices Incentive to borrow today to consume perceived higher future housing wealth Transform future housing wealth in present consumption with Home Equity Loans Banks’ optimism allows households’ borrowing. Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 4 / 32 Introduction Home Equity Extraction 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 ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 5 / 32 Introduction Home Equity Extraction Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 6 / 32 Introduction What we do: Empirically Parsimoniously model biased expectation for house price 1 Natural agents fail to estimate the medium- long-run properties of house prices 2 Document that financial expert had biased expectations Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 7 / 32 Introduction What we do: Theoretically Modelling Natural Expectations and Home Equity Extraction Households and Banks meet in the credit market Households pledge their house as collateral to obtain credit. Allow for both agents being natural Assess the effect of biased expectations during 2000-2010 Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 8 / 32 Introduction Findings Quantifying the Role of Natural Expections Debt to Income Ratio: 16% higher for natural households during boom Interest Rate: lower for natural agents Vulnerability: higher for natural agents when house prices decline Biased expectation contributed to Economy Excessively Exposed Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 9 / 32 House Price and HEE Outline House Prices and Home Equity Exctraction Modelling Home Equity Extraction Natural Expectations for House Price Quantifying the Role of Optimism in the Credit Market Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 10 / 32 House Price and HEE Home Equity Loans 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1995 2000 2005 2010 Figure: Revolving Home Equity Loans in the U.S.: Trillion of dollars Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 11 / 32 House Price and HEE Home Equity Loans and House Prices 6 200 5 180 4 160 3 140 2 120 1 1995 2000 2005 100 Figure: Home Equity Loans-Disposable Income ratio and U.S. House Price index Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 12 / 32 House Price and HEE Home Equity Extraction and Education Education Category 1 2 3 4 5 6 Average 1998 19.3 23.7 15.8 14.8 13.5 14.2 14.1 HELOC Exposure 2001 2004 2007 13.4 31.5 5.7 7.5 20.5 11.7 15.5 16.0 9.8 14.9 12.8 15.9 13.1 16.4 11.8 19.8 16.3 14.7 16.2 16.9 13.0 HELOC Participation 1998 2001 2004 2007 0.3 2.2 3.5 3.2 2.3 2.4 2.4 3.6 3.8 3.6 6.4 8.0 4.5 4.9 7.7 9.4 6.0 7.0 12.0 10.6 7.8 6.4 12.7 13.6 4.8 5.0 8.9 9.5 Table: Heloc for Education Categories: Survey of Consumer Finance Duca and Kumar (2014): Financial illiteracy affected Home Equity Extraction Agurwar and Mazumder (2013): Cognitive ability affects House price forecast precision Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 13 / 32 Model Outline 1 House Prices and Home Equity Exctraction 2 Modelling Home Equity Extraction 3 Natural Expectations for House Price 4 Quantifying the Role of Optimism in the Credit Market Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 14 / 32 Model Elements of the model Infinitely lived economy Two agents: Household and Bank Two goods: consumption and housing Household owns house and pledge it as collateral Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 15 / 32 Model Household Problem max{ct ,dt ,deft }Tt=0 EH 0 T X β t u(ct , h), t=0 deft =0: ct + (1 + rt−1 )dt−1 = y + dt deft =1: ct + γpt h = y Expectation Bias h pt+1 = pt 1 + rt+1 , h rt+1 = Θp (L)rth + σεt+1 , , Default Probability 1 1 + rt Pr {deft+1 = 1} = Pr εt+1 ≤ dt − 1 − Θp (L)rth σ pt (1 + γ)h Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 16 / 32 Model Bank Problem (rt−1 − it−1 )dt−1 + δEBt πt+1 (rt , dt , pt+1 ) if the household does not default (and did not default in the past) κpt h − (1 + it−1 )dt−1 max πt (rt−1 , dt−1 , pt ) = if the household defaults dt (but did not in the past) 0 if the household defaulted in the past. Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 17 / 32 Natural Expectations for House Price Outline 1 House Prices and Home Equity Exctraction 2 Modelling Home Equity Extraction 3 Natural Expectations for House Price 4 Quantifying the Role of Optimism in the Credit Market Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 18 / 32 Natural Expectations for House Price Question for you What was the real appreciation of the average U.S. house price (index) from 1955 to 2000? Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 19 / 32 Natural Expectations for House Price Question for you What was the real appreciation of the average U.S. house price (index) from 1955 to 2000? Answer: 0%! Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 19 / 32 Natural Expectations for House Price Question for you What was the real appreciation of the average U.S. house price (index) from 1955 to 2000? Answer: 0%! Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 19 / 32 Natural Expectations for House Price U.S. House Prices 5.4 5.2 5 4.8 4.6 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 0.1 0 −0.1 −0.2 1955 Figure: Real U.S. House Price index (upper panel) and its growth rate (lower panel) Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 20 / 32 Natural Expectations for House Price Natural and Rational Agents (1 − Φp (L)) rt = µ + εt Natural agents estimate and forecast using AR(1) [Fuster et al. (2012), Hommes and Sorger (1998), Hommes and Zha (2013)] Rational (Sophisticated) agents estimate and forecast using BIC/AIC BIC: p=5 // AIC: p=16 Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 21 / 32 Natural Expectations for House Price Natural and Rational Estimates p φ1 φ2 φ3 φ4 φ5 φ6 φ7 φ8 φ9 φ10 φ11 φ12 φ13 φ14 φ15 φ16 Natural 1 0.958∗∗∗ [0.02] Whole Sample: 1953:1-2010:4 Sophisticated BIC Sophisticated AIC 5 16 1.330∗∗∗ 1.348∗∗∗ [0.06] [0.07] −0.221∗∗ −0.241∗∗∗ [0.10] [0.11] 0.09 0.122 [0.10] [0.12] ∗∗∗ −0.614 −0.841∗∗∗ [0.10] [0.12] 0.355∗∗∗ 0.656∗∗∗ [0.06] [0.12] 0.012 [0.13] −0.060 [0.13] −0.457∗∗∗ [0.13] 0.346∗∗∗ [0.13] 0.055 [0.13] 0.121 [0.14] −0.631∗∗∗ [0.13] 0.285∗∗ [0.12] 0.050 [0.13] 0.136 [0.13] −0.119 [0.08] Natural 1 0.914∗∗∗ [0.00] φ17 σ 0.014 0.012 0.011 0.014 R2 0.91 0.94 0.95 0.83 Pancrazi, Pietrunti (23.7 University of Warwick, Economics,Natural Banca d’Italia) HEE 11.6 LRP 18.3Toulouse School of10.4 Subsample: 1953:1-1996:4 Sophisticated BIC Sophisticated AIC 13 17 1.052∗∗∗ 1.118∗∗∗ [0.08] [0.08] −0.024 −0.136 [0.11] [0.13] 0.1131 0.194 [0.11] [0.12] ∗∗∗ −0.695 −0.805∗∗∗ [0.11] [0.12] −0.540∗∗∗ 0.652∗∗∗ [0.14] [0.12] 0.077 0.004 [0.13] [0.14] −0.073 −0.006 [0.13] [0.14] −0.459∗∗∗ −0.562∗∗∗ [0.13] [0.14] 0.425∗∗∗ 0.485∗∗∗ [0.12] [0.14] 0.049 0.013 [0.11] [0.14] 0.039 0.148 [0.11] [0.14] −0.467∗∗∗ −0.653∗∗∗ [0.11] [014] 0.218∗∗∗ 0.403∗∗ [0.08] [0.14] −0.118 [0.12] 0.211∗ [0.12] −0.291∗∗ [0.08] 0.105 [0.08] 0.093 0.090 0.89 0.90 AMSE, 4.8 4.4 4 Dec. 2013 22 / 32 Natural Expectations for House Price Natural and Rational Impulse Response (1 − Φp (L)) rt = µ + εt 2 Naive: p=1 Soph.BIC: p= 5 Soph.AIC: p=16 1.5 1 0.5 0 −0.5 −1 0 10 20 30 40 50 60 70 80 90 100 90 100 25 20 15 10 Naive: p=1 Soph.BIC: p= 5 Soph.AIC: p=16 5 0 0 10 20 30 40 50 60 Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE 70 80 AMSE, 4 Dec. 2013 23 / 32 Natural Expectations for House Price Natural Financial Experts We gather and analyze a unique data set. Source: Moody’s Analytics Out-of-sample forecasts by using a rich demand-supply model (income trends, demographics cyclical factors) Quarterly forecasts from 1995-2011 30 years horizon (quarterly) Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 24 / 32 Natural Expectations for House Price Financial Experts Forecast 180 170 160 1997 2000 2002 2004 2006 Realized 150 140 130 120 110 100 90 80 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 Figure: Financial Experts Real House Price Out-of-Sample Forecasts Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 25 / 32 Natural Expectations for House Price Natural Financial Experts 5.4 5.3 AR1-Forecast AR13-Forecast Actual Forecast Realized Prices 5.2 5.1 5 4.9 4.8 4.7 4.6 2000 2005 2010 2015 2020 Figure: Natural Forecast, Rational Forecast, and Financial Expert’s Forecast Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 26 / 32 Quantifying the Role of Optimism in the Credit Market Outline 1 House Prices and Home Equity Exctraction 2 Modelling Home Equity Extraction 3 Natural Expectations for House Price 4 Quantifying the Role of Optimism in the Credit Market Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 27 / 32 Quantifying the Role of Optimism in the Credit Market Empirical Strategy Discretize house price growth rate (3 nodes) Solve the model by backward induction Natural Agents: AR(1) Rational Agents (DGP): AR(2) ρ1 ρ2 σ Long-Run Persistence (LRP) Standard Deviation First-order Autocorrelation Natural - AR(1) 0.72 0.033 3.59 0.034 0.724 Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE Rational - AR(2) 0.97 -0.58 0.027 1.63 0.027 0.728 Annual Data 1.63 0.027 0.728 AMSE, 4 Dec. 2013 28 / 32 Quantifying the Role of Optimism in the Credit Market Calibration Parameter β=δ h η y γ κ Value 0.98 1.5 2 1 0.05 0.2 Description Discount rate for household and banks Housing stock CRRA coefficient Income per year Rental rate as a fraction of house value Collateral value for the bank as a fraction of house value housing price 1.4 1.2 1 1 2 3 4 5 6 7 8 9 Figure: Simulated house price Dynamics (2001-2009) Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 29 / 32 Quantifying the Role of Optimism in the Credit Market During House Price Boom (1) Both Rational, (2) Both Natural, 1 Natural household extracts more than 2 times than rational 2 At a lower interest rate 3 Natural household consumes more Natural household 4 times more vulnerable 4 Scenario Debt to income (%) Cons to Income (%) Loan to Value (%) Interest Rate (%) Debt Service Ratio (%) Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE Boom (1) (2) 8.8 21.9 4.92 4.96 4.64 12.49 3.17 2.95 3.83 16.93 AMSE, 4 Dec. 2013 30 / 32 Quantifying the Role of Optimism in the Credit Market During House Price Bust 1 Abrupt deleveraging for natural household 2 Similar level of vulnerability 3 Rational household keeps constant DRS Scenario Debt to income (%) Cons to Income (%) Loan to Value (%) Interest Rate (%) Debt Service Ratio (%) Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE Bust (1) (2) 8.1 5.9 -10.8 -11.4 4.16 3.07 2.11 2.11 18.87 17.33 AMSE, 4 Dec. 2013 31 / 32 Conclusions Conclusions Housing: asset with large value and hard to forecast Financial market for housing: exposure to biased expectations Using a quantitative model, we find large effects due to biased expectations Pancrazi, Pietrunti ( University of Warwick, Toulouse School of Economics,Natural Banca d’Italia) HEE AMSE, 4 Dec. 2013 32 / 32