| In a model with housing collateral, the ratio of housing wealth to human wealth shifts the conditional distribution of asset prices and consumption growth. In the model, a decrease in house prices reduces the collateral value of housing, increases household exposure to idiosyncratic risk, reduces the amount of income risk shared and increases the conditional market price of risk. Using aggregate data for the US, we find that a decrease in the ratio of housing wealth to human wealth predicts higher returns on stocks. Conditional on this ratio, the covariance of returns with aggregate risk factors explains up to eighty percent of the cross-sectional variation in annual size and book-to-market portfolio returns. Regional risk-sharing patterns for US metropolitan areas lend direct support to the housing collateral channel. In times with a high housing collateral ratio, consumption growth is more strongly correlated across regions. Time-variation in the degree of risk-sharing induced by house price changes sheds new light on the consumption correlation puzzle. |
