‘Real estate derivatives’ could end negative equity, academics claim

‘Real estate derivatives’ could end negative equity, academics claim

Creating a new financial product that allows banks to ‘hedge’ against the prospect of house prices falling could help remove the threat of negative equity, say academics.

That’s the conclusion of new research carried out by Professor Radu Tunaru of the Kent Business School at the University of Kent, Nobel Prize winner Professor Robert Shiller of Yale University, and Professor Frank Fabozzi of the EDHEC Business School in France.

The academics suggested that homeowners could link their property to a financial product when selecting their mortgage. This product would ensure that if the value of the property fell, leaving them in negative equity, they could recoup the difference from the fund which had hedged against house prices.

However, if house prices rose, homeowners would not benefit from the gains in the value of the property, as they would be balanced out by the losses of the fund.

The researchers argued that as most people buy a property so that they have somewhere to live, rather than as an investment, buyers may prefer this “risk averse strategy” when purchasing a property.

The researchers also suggested that with so much economic wealth in nations like the UK tied up in property, house price derivative products would act as a defence against the impact of any significant economic downturns, such as the financial crisis.

The paper – Evolution of Real Estate Derivatives and Their Pricing – has been published by IPR Journals in The Journal of Derivatives.

Tunaru argued the research demonstrated that property derivatives would “provide more stability”, adding: “This could help remove a lot of the uncertainty when purchasing a house and avoid the risk of negative equity, which is often a major concern for homeowners.”

SOURCE: mortgagesolutions

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