Hedging House Price Risk in China

The increasing risk associated with China's housing prices is globally recognized. However, hedging this risk is challenging because of a lack of financial derivatives on China's housing assets. We suggest that the short sale of futures contracts for construction raw materials, i.e., iron ore or/and steel, can act as useful tools to hedge the systematic risk of China's new home price. We first present evidence that there is a strong and stable correlation between changes in China's housing prices and global steel/iron ore prices. Using a hedging strategy model, we then show that, during the sample period between 2009 and 2015, 20.6% of the total unpredicted variance in Chinese housing prices can be hedged by shorting rebar and iron ore futures. We further examine this strategy with an event study based on the announcement of the home-purchase restriction policy in April, 2010. The cumulative abnormal returns show that both steel and iron ore prices reacted significantly to this negative shock, and therefore the proposed strategy could substantially help investors offset losses in the housing market. We finally provide some evidences that this strategy can also help investors in specific regional housing markets, or the resale housing markets.