Risk Markets And Politics

Thursday, March 23, 2006

The Housing Futures Are Coming

Mark your calendar. On April 26th, futures on the newly-dubbed S&P Case Shiller Home Price Indexes will begin trading on the CME. It's not everyday that a $20-odd trillion asset class opens itself to exchange-traded contracts. This development was the subject of Tuesday's event in New York where the index's namesakes and others spoke and later fielded questions in a roundtable discussion moderated by economist and commentator Dennis Gartman.

We all know the arguments in favor of this market, and the latest contract details will soon be posted by the CME, so let's skip directly to the concerns voiced by attendees.

First and foremost, inquiring minds wished to know who the buyers would be. Hedging sellers abound from individuals to homebuilders to mortgage issuers and federal agencies to local governments. The natural buyers would be prospective home-buyers, trying to ensure that they aren't priced-out of the market, but the relative wealth of that group is - naturally - very small. This is by no means a fatal problem, but it is an obstacle to the market realizing volume and liquidity.

Ideally, the abundance of non-information traders (hedging sellers) would attract speculative buyers. Speculators, however, may be unwilling to stand against the massive weight of hedging, especially with such an infrequent spot price. Fortunately, it was announced that updates on the quarterly index would be released monthly on the last Tuesday of each month. It was suggested that the existing housing-related data releases such as sales, permits, starts, and completions would help to fill in the data void. Karl Case added that traders would no doubt gather their own information and that the futures would come to reveal this. Whether or not enough information can be gathered to overcome the influence on price of hedging, especially at the national level, is an open question. Robert Shiller noted that the term structure of the futures would likely settle into backwardation.

Lack of transparency and the "black-box" nature of the index was another big concern. Happily again, CSW announced that they would soon be publishing the full details of the methodology. Thus two of the major infelicities mentioned here in November were rather squarely addressed.

While most of the concerns dealt with the viability of the futures market itself, there was also the worry that the contract would increase the volatility of the underlying real estate, otherwise a relatively calm asset class. Robert Shiller brushed this off, saying that housing was already "like the stock market", a danger a questioner had posed. Dr. Shiller also noted the possibility of home prices being quoted in terms of futures prices. That is, rather than a fixed amount, the asking price might be advertised as some multiple of the appropriate regional index. That separate, earlier remark probably did little to sooth the worries of whoever asked the volatility question.

Skepticism inevitably surrounds new markets. Dennis Gartman recalled the eyebrows initially raised, for instance, at Nymex's crude oil futures. Again, residential real estate in the US tallies in at approximately $20 trillion dollars. One basis point (one percent of one percent) of 20 trillion is 2 billion, so volume may be impressive despite the worries. In terms of popularization, there was a good deal of talk concerning indirect trading of the futures, and it was suggested that most individuals would actually come into contact with the futures through OTC instruments packaged by institutions or through index-linked mortgages. An AMEX ETF tied to the index is also in the works.


  • And what about real estate developers?

    By Anonymous Anonymous, at 9:55 AM  

  • I had just called Robert Schillers company that controls the index on RE as an investigation for our firm, and two days later the CME press release came out. They didn't get back to me, for obvious reasons.

    The concerns about volatility are valid when viewed through the perspective of common understanding of volatility. Because housing prices are updated so infrequently now, it appears there is less volaitlity then something that would be updatedd on a daily or by minute basis. In reality, these housing prices must fluctuate far, far more than either the lack of updated prices suggest or than any smoothed appraised value would indicate. Whats going to happen is this volatility will be made visable for the first time.

    The backwardation argument is very powerful, as there are so many natural sellers. Also, as these contacts will converge to a price that should be close to market prices (according to Schiller), it may be possible to earn powerful returns simply from going long this contract and earning the roll return.

    If you don't know who Hillary Till is, she is really the expert on this type of return. I am goig to write her about this and find out what she has to say. I'll point her to your blog.

    take care-

    By Blogger Unknown, at 3:17 PM  

  • theres a bloomberg AV on this up right now Robert Schiller speaking with a bloomberg interviewer.

    By Blogger Unknown, at 4:27 PM  

  • Thanks for the pointers, Mike.

    When Shiller mentioned backwardation, he cited Keynes' normal backwardation to which Gartman objected "No, Keynes was wrong!" although Gartman apparently didn't disagree with the idea that the housing futures will tend towards backwardation.

    It seems like limit-order buying ahead of the monthly updates could work well. I'd guess that trade will be most active after each update and then dissipate over the course of the month. Leaving some limit buys in during that period sounds reasonable. Trading will be weird though, and it might be instructive to look back at the initial months of trade in WTI and other futures. There's a tradeoff between trying to exploit early inefficiencies in a dangerous market versus waiting a few months so that one has a better idea of what to expect.

    By Blogger Jason Ruspini, at 11:44 AM  

  • No doubt, early adopters are exposed to more risk. Typically there are 1 or two who somehow figure it out very quickly and make giant profits.

    Quarterly expiry with monthly index updates, plus the usual range of other information. Hmm...

    Have you heard of DataQuick? They are a database of real estate information that would be very similar to what Schiller is going to use as inputs. If the technique is truly transparent, one might be able to recontstruct it, or constuct a highly correlated index, from that information. You could then update the data more frequently than many in the market. The data isn't that expensive and it is possible.

    This might actually be a good trade, for the first few years at least. Right now, I don't have any idea what the volume might be, this market isn't already familar with using hedging tools, so it might be a longer time before significant adoption by these natural longs.

    By Blogger Unknown, at 3:51 PM  

  • "whoever asked the volatility question"
    I have put some volatilities on my website for the 10 cities => long term close to the stock market,short term wild divergence between cities

    By Anonymous Anonymous, at 2:21 PM  

  • Mike, yes, the creators of the indexes encourage people to replicate them as that will increase the usefulness of the futures. With the 2 month lag, this could be viable. I would bet that the futures will react to NAR and OFHEA releases as well in spite of the different methodologies, at least early-on.

    thanks jck. To be clear, the #s on your site look like annual returns as opposed to annualized volatilities. The latter are much smaller because of the autocorrelation in these markets. (And anyone looking at the monthly numbers, remember those are rolling quarterlies, not independent data points.)

    It will be interesting to see the implied vols when the options begin to trade, and even the margin requirements, which from what I hear will be announced as late as possible.

    By Blogger Jason Ruspini, at 9:46 PM  

  • From The Economists' Voice, Robert Shiller 's Long-Term Perspectives on the Current Boom in Home Prices

    In a nutshell: homes do not exhibit systematically higher real prices over the long term (100 years+, although there does seem to be a long-term downtrend in real rents.) The current boom is rather unique and its magnitude is unexplained. This higlights the need for hedging instruments.

    Mike Linksvayer's previous suggestion that parents would buy housing futures for their children was interesting, but implies a world where housing prices are in a long-term uptrend ("like the stock market") This paper suggests not, but one might ask, how long is long-term? Shiller notes: "It is thus surprising that the real price of American housing, also shown in Figure 3, has had an uptrend since 1913—although, as noted above, there is no long-term uptrend if pre-1913 years are taken into account."

    By Blogger Jason Ruspini, at 12:58 PM  

  • www.HomePriceMaps.com integrates how much homes SOLD for nationwide using the google mapping technology. Simply select city and state from the city menu and click search. If you don't see data for your area simply email HomePriceMaps@gmail.com with your zipcode and or address and they'll update the site with your info and email you within a few days.

    By Blogger h, at 5:11 PM  

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