HEDGING HOUSE PRICE RISK WITH INDEX-BASED REAL ESTATE DERIVATIVE: EVIDENCE FROM SINGAPORE PRIVATE RESIDENTIAL MARKET

Abstract

Residential homeowners in Singapore have limited ways to protect against the property market downside risk where acute price correction and erosion of household wealth may occur. In light of the lack in suitable hedging instruments for residential property owners, this study investigates whether an index-based derivative product can be effective in hedging house price risk in Singapore private residential market. Using SRX Property Index and private residential transaction data from January 1995 to August 2017, this study replicates the study by Bertus et al. (2008) to evaluate hedging effectiveness by using an index-based futures contract. Results from the base analysis shows a hedging effectiveness of 20 to 50% across all sample groups in the entire sample period. The analysis is subsequently repeated across three separate risk regimes, namely the Asian Financial Crisis, the Dot-Com Crisis and the Global Financial Crisis, where hedging results are generally effective. Additional robustness analysis suggests that hedging duration and transaction volume are both influential to the hedging effectiveness. Lastly, it is found that correlations between individual home value and index value are key factor contributing to an effective hedging in the property market.