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Can the wealth-to-income ratio be a useful predictor in alternative finance? Evidence from the housing risk premium

Armada, Manuel J. Rocha and Sousa, Ricardo M. (2012) Can the wealth-to-income ratio be a useful predictor in alternative finance? Evidence from the housing risk premium. In: Jawadi, Fredj and Barnett, William A., (eds.) Recent developments in alternative finance: empirical assessments and economic implications. International symposia in economic theory and econometrics (22). Emerald Group Publishing Limited, Bingley, UK, pp. 67-79. ISBN 9781781903995

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Identification Number: 10.1108/S1571-0386(2012)0000022009

Abstract

Purpose – The purpose of this chapter is to assess the role of the wealth-to-income ratio in forecasting housing risk premium. Methodology/approach – To investigate this issue, the chapter uses the residuals of the trend relationship among asset wealth and labor income to predict future real housing returns. It shows that deviations of asset wealth from its cointegrating relationship with labor income, wy, track time-variation in expected housing returns. Findings – Using data for a set of industrialized countries, this chapter finds that if agents are hit by a shock that generates a fall in the wealth-to-income ratio, they will demand (i) a higher housing risk premium when housing assets are complements of financial assets and (ii) a lower housing risk premium when housing assets are substitutes of financial assets. Originality/value of chapter – The findings of this chapter are novel in the field of alternative finance and, in particular, durable (housing) finance. Indeed, they build on a representative agent's theoretical model to infer about the degree of substitution or complementarity between financial and housing assets, which, in turn, can be useful at developing investment strategies for hedging against the risk of unfavorable housing fluctuations. Additionally, they open a new research avenue for understanding the determinants of housing risk premium by linking the dynamics of asset wealth and labor income with the behavior of future housing returns.

Item Type: Book Section
Official URL: http://www.emeraldinsight.com/
Additional Information: © 2012 Emerald Group Publishing Limited
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Sets: Research centres and groups > Financial Markets Group (FMG)
Date Deposited: 28 Apr 2014 15:53
Last Modified: 28 Apr 2014 15:53
URI: http://eprints.lse.ac.uk/id/eprint/56596

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