Document Type
Article
Publication Date
6-2021
Publisher
Elsevier
Source Publication
Journal of Macroeconomics
Source ISSN
0164-0704
Abstract
This paper investigates how real estate wealth affects the household’s attitude toward risk, and derives the closed-form expressions for risk aversion with generalized recursive preferences. We find three channels through which real estate wealth affects risk aversion, and these channels are absent in the traditional measure of relative risk aversion as in Arrow (1965) and Pratt (1964). First, illiquidity and fluctuations in real estate value increase consumption risk, thereby increasing risk aversion. Second, real estate as an asset provides a cushion for absorbing negative shocks to households, reducing risk aversion. Third, an increase in real estate prices lowers the profit of the firm that uses real estate as a factor of production, induces a decline in the real wage, and causes a rise in consumption risk. This channel increases risk aversion. We study how these channels as a whole determine relative risk aversion using a basic real business cycle model with generalized recursive preferences and compare the results with the case of expected utility preferences. Finally, we explore the implications of the firm’s and the household’s real estate holdings and illiquidity of real estate on the risk premiums for equity and real estate.
Recommended Citation
Huh, Sungjun and Kim, Insu, "Real Estate and Relative Risk Aversion with Generalized Recursive Preferences" (2021). Economics Faculty Research and Publications. 615.
https://epublications.marquette.edu/econ_fac/615
Comments
Accepted version. Journal of Macroeconomics, Vol. 68, (June 2021): 103310. DOI. © 2021 Elsevier. Used with permission.