Derivatives to manage house credit and price risk
On the side of residential owner-occupied housing, Hinkelmann and Swidler (2006) are sceptic as to whether the market can take off. Mentally, homeowners tend to treat their home just as a consumption good rather than as an investment that involves price risk. Moreover, they would always be subject to a huge tracking error risk when hedging their homes with derivatives based on house price indices. This limits the effectiveness of hedging, and individuals may not use derivatives to manage house price risk. Ultimately, a lack of hedgers in the marketplace may lead to failure of residential housing derivatives such as the Chicago Mercantile Exchange (CME) housing futures contracts. It remains to be seen whether the involved challenges and hurdles can be successfully addressed.
History shows that the buildup period of a new market is very fragile. Property derivatives were launched in the early 1990s and actually failed. The debut on the London Futures and Options Exchange (FOX) crashed in a combination of bad timing and scandal over false trades designed to create the impression of higher activity (see experience in property derivatives).
Today, liquidity in the property derivatives market has a good chance of being increased. In 1981, the first interest rate swap was done. Although people were sceptic at the time, it is now a trillion dollar market. The property market could experience a similar sort of growth in derivative instruments.
Basis for two-year total tax return
Starting in November 2006, Colliers International and interdealer broker GFI formed a joint venture, GFI Colliers, that offers brokerage services for derivative contracts on the Hong Kong University–Hong Kong Residential Price Index (HKU–HRPI). The index, complied by the University of Hong Kong, is based on transaction figures from the Land Registry. Hong Kong has long attracted attention in the global property world due to the volatility of its real estate prices. The HKU–HRPI was offered at 650 basis points over HIBOR or a total of roughly 10.5 %. ABN Amro and Sun Hung Kai Financial announced in February 2007 that they had traded a property swap based on Hong Kong’s residential market. The inaugural transaction in Asia, at less than HK$ 100 million (US$ 13 million), was traded as a one-year price return swap. As buyer of the derivative, ABN Amro gained exposure to the city’s housing market by receiving the annual change in the index. By September 2007, five global banks have received licenses to trade Hong Kong residential property derivatives.
The first Italian property derivative transaction, based on the IPD Italian Property Index, was carried out between Grosvenor and BNP Paribas in October 2007. ICAP acted as a broker for the trade that took the form of a two-year swap.
Further, Grosvenor and Royal Bank of Scotland have traded the first Japanese property derivative in July 2007. The monthly IPD Japan Property Index was used as the basis for the two-year total return swap. It was the first derivatives trade on commercial property in Asia, following the launch of a residential property derivatives market in Hong Kong. IPD uses data provided by Japanese real estate investment trusts (J-REITs) to calculate the index.
