Housing Collateral and Consumption Insurance Across US Regions

Abstract

Time-variation in the degree of risk-sharing induced by changes in the value of housing collateral sheds new light on the consumption correlation puzzle. If debts can only be enforced to the extent that they are collateralized by housing wealth, a decrease in the value of housing collateral endogenously increases exposure to idiosyncratic risk. This increases the cross-sectional consumption growth dispersion across regions and it reduces the amount of regional income risk shared. We investigate risk-sharing patterns for the 30 largest US metropolitan areas and find empirical support for the housing collateral channel. In times when housing collateral is scarce, the dispersion of consumption growth relative to income growth is twice as high as when collateral is abundant. A structural estimation of the model's consumption dynamics implies a time path for consumption growth dispersion that matches the one in the data. The housing collateral effect is the key element that enables this match.