How Much Extra Premium Does a Loss-Averse Owner-Occupied Home Buyer Pay for His House?

Posted: 19 Nov 2012

See all articles by Mao-Wei Hung

Mao-Wei Hung

National Taiwan University

Leh-chyan So

National Tsing Hua University

Date Written: November 19, 2012

Abstract

The dual role of houses as durable consumption goods and as financial investments makes the option approach a suitable method for evaluating them. When the buyer of an owner-occupied home spends a large amount of money on a house, he pays the bill to cover not only construction costs but also the premium for an at-the-money call on the house. With loss aversion, he believes that if the house price rises from its current price (i.e., the strike price), he may make a profit by selling the house. On other hand, if the house price drops, he just keeps the house to wait for a better selling price, and treats the house as a durable good that provides him with shelter. The dual role of houses enables the homebuyer to enjoy the upside potential from the viewpoint of investment, but to eliminate the downside risk from the viewpoint of consumption. As a result, we propose that homebuyers are often willing to pay more for a house as a call premium. In addition, both the homeownership contraint and the homebuyer's ambiguity aversion will influence his subjective evaluation of the call.

Keywords: Call premium, Homeownership contraint, Ambiguity aversion

Suggested Citation

Hung, Mao-Wei and So, Leh-chyan, How Much Extra Premium Does a Loss-Averse Owner-Occupied Home Buyer Pay for His House? (November 19, 2012). Journal of Real Estate Finance and Economics, Vol. 45, No. 3, 2012, Available at SSRN: https://ssrn.com/abstract=2178107

Mao-Wei Hung

National Taiwan University ( email )

50 Lane 144, Section 4
Taipei 32026
Taiwan

Leh-chyan So (Contact Author)

National Tsing Hua University ( email )

Hsin Chu
China

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