House prices, (un)affordability and systemic risk

Abstract

This is the first paper to examine the role of the real estate sector and housing unaffordability in the determination of systemic risk. We measure the systemic risk of the UK by employing the method developed by Adrian and Brunnermeier [(2016). CoVaR. American Economic Review, 106(7), 1705–1741] and we explore both its cross-sectional and time series behaviour. Regarding the former, we show that when the real estate sector is under distress the tail risk of the entire financial system increases significantly. With respect to the latter, the findings of our dynamic model suggest that sustainable house prices positively contribute to the stability of the financial sector; whilst house price exuberance and rapid increases in housing unaffordability amplify systemic risk. Finally, we examine the conjecture that the banking sector comprises a transmission channel from the housing market to systemic risk. Our empirical results are in line with this argument and highlight the key role of housing unaffordability.