Book Description

Real estate is the largest component in most American households' portfolios. Prior studies have shown both negative and positive relations between uncertainty and households' housing decisions. This dissertation makes an effort to reconcile the differences in the literature through theoretical and empirical work that links uncertainty and households' housing decisions from a real options perspective. In the first chapter, I provide novel empirical evidence to show the importance of uncertainty in explaining households' several housing decisions - housing consumption, housing investment and mortgage default. After controlling for unobserved heterogeneity, I find that the effect of uncertainty has opposite signs on housing purchase decisions depending on the type of purchase (primary residence or investment property). I also find that uncertainty contributes to households' default decisions beyond other factors that have previously been identified in the literature. In addition to identifying the sign of the effect of uncertainty, I show that the uncertainty effect varies depending on the household's risk aversion, which is consistent with the predictions from a theoretical real options perspective. The second chapter introduces a real options type of model to explain from a theoretical perspective why the effect of uncertainty on households' home purchase decisions can depend on the type of a home purchase. Based on a real options approach introduced in Miao and Wang (2007) the model captures the dual nature of housing as a consumption good and an investment vehicle. It explains the uncertainty effect on the optimal timing of home purchase decisions either as a consumption good or as an investment. Unlike previous studies that rely on risk-neutral assumptions in the valuations of real options in explaining uncertainty effect on households' decisions, the model recognizes idiosyncratic risks and households' precautionary saving motives which allow the effect of uncertainty to vary across different degrees of risk-aversion. The third chapter introduces a real options type of model to explain the effect of uncertainty on households' default decisions. Unlike previous studies that focus on the link between uncertainty and investment decisions,the model shows the usefulness of a real options approach in explaining households' default decisions. The model predicts a positive relation between uncertainty and households' default decisions, which is consistent with the empirical results from the first chapter.