Seminar in the Economics, Finance and Accounting Department - Consumption spending, housing investments and the role of leverage

Friday, April 5, 2019 - 15:00 to 16:30
Dept of Economics, Finance and Accounting, Edgeworth Room, Room 31 Rhetoric House

In the years prior to the financial crisis, house price increases in many countries were accompanied by significant increases in household debt. In this paper, we combine panel data on house hold wealth and leverage with detailed household spending survey data to examine the borrowing, spending and investment decisions of existing homeowners in response to house price increases.

We use variation in credit conditions over time to isolate exogenous differences in households’ leverage positions. We find that households who were initially more leveraged are more likely to both purchase other residential properties and invest in their own homes in response to local house price increases than other households. However they do not disproportionately increase their consumption spending as house prices rise, as would be expected if household spending were driven by traditional housing wealth effects. We show how this behaviour can be rationalised in a framework where households treat leverage as a portfolio choice, choosing leverage to optimise the risk and return on their assets. Households respond to house price increases by borrowing and investing in housing (including their own homes) in order to maintain their desired loan-to-value ratios.