Housing rare disaster events and asset prices

Abstract

This study revisits the interaction between housing consumption dynamics and the level and term structure of equity risk premia and interest rates. The existing literature on housing consumption fails to explain asset prices when using acceptable preference parameters for the representative investor. By taking into account rare economic disasters events in the dynamics of both standard and housing consumption applied to U.S. data between 1959 and 2020 our model is able to solve long-standing asset pricing puzzles while accommodating upward and downward-sloping term structures of risk premia. These findings show that the housing sector plays a crucial role in explaining the dynamics of financial markets and offers new insights for investors and policy makers alike on how to incorporate housing dynamics into investment decisions and regulations.