Idiosyncratic Volatility and the Housing Market

Abstract

Housing investment is largely undiversified and differs from financial assets (e.g., stocks) in that it serves the dual purpose of investment and consumption. Transaction costs and liquidity risk are also much higher for housing assets. These important differences among suggest that idiosyncratic volatility may play an important role in explaining the performance of the U.S. housing market. This hypothesis is evaluated by using disaggregate housing data based on the median-priced house sale in 7,234 ZIP Codes comprising the U.S. metropolitan housing market. The results indicate that idiosyncratic volatility plays a strong positive role on housing returns in the cross-section and that the relation is robust to the price level and socioeconomic variation among housing submarkets. These findings further suggest that idiosyncratic volatility acts as an important reduced-form factor for local supply-demand conditions that operate autonomously of systematic economy-wide drivers.