Summary: Summary: The unprecedented rise in China's household leverage has attracted a great deal of public attention. In this paper, we examine how household borrowing responds to large movements in asset prices. The answer to this question is fundamental in macroeconomics and finance and has crucial implications for understanding how asset price shocks generate business cycle fluctuations. The literature suggests that high household leverage might lead to increased mortgage default rates and trigger an economic recession (Midrigan and Philippon, 2011; Mian and Sufi, 2009, 2011). Another line of research has tried to explain the increase in household leverage by the rise in house prices (Hurst and Stafford, 2004; Cooper, 2009; Mian and Sufi, 2011). These studies have documented an important collateral channel whereby an increase in the value of a self-owned house will relax the household's financial constraints, and make the household borrow and consume more. However, the sudden increase in household leverage in China has yet to be explained. In this paper, we examine whether the collateral channel exists in China. We also propose two additional channels via which the surge in house prices may have contributed to the sudden increase in household leverage. Based on household level housing and debt information drawn from the Chinese Family Panel Studies (CFPS) for 2014 and 2016, we show that the appreciation in house prices indeed contribute to the increase in household leverage. Quantitatively, we find that a 100% increase in the price of a house leads to 288.1% and 39.2% increases in household debt and leverage, respectively. By further splitting our sample into several subsamples, we also find that the house price movements have heterogeneous effects on household leverage. Specifically, we find that urban hukou households with spouses and children have a greater increase in household leverage than rural hukou households without spouses and children. Moreover, we find that some of the data patterns are at odds with or cannot be well explained by the “collateral channel.” Therefore, we propose two additional channels, the “financing channel” and the “speculation channel,” and confirm that these channels have a strong influence on our sample. Furthermore, we find that most households finance their housing purchases by bank loans instead of private lending. Our paper contributes to the literature on household leverage in two important ways. First, the “borrowing for housing purchase” scenario provides a possible explanation for the unprecedented increase and highly imbalanced geographical distribution of household leverage in China. Since 2000, the literature has increasingly focused on the rapid expansion of total household debt and household leverage in developed countries, and views this changing pattern as the product of the increased availability of mortgage credit and other innovative consumption loans in the U.S. and Europe (Casolaro et al., 2006; Mian and Sufi, 2011). However, to the best of our knowledge, no studies have sought to explain the features of household leverage in China. In this sense, this paper is the first attempt to build a bridge between these two vitally important characteristics of Chinese economy, namely, the rapid increases in the housing prices and household leverage in big cities. Second, our paper contributes to the literature by providing three channels through which increased housing prices might lead to increased household leverage. In particular, the two additional channels proposed in this paper complement the collateral channel examined in the literature (Berger et al., 2015; Aladangady, 2017; Cheng, 2017). The collateral model shows that increased house prices can relax the households' borrowing constraints by increasing their collateral value, and thereby generate significant increases in household consumption and leverage (Ortalo-Magné and Rady, 2008; Mian and Sufi, 2011), which is most relevant to our paper. However, distinct from the literature, we find that there is no collateral channel in our sample. A possible explanation for this finding is that the rise in house prices is more significant and persistent after 2008 than before 2008, thus increasing the incentives for speculation in the later period.
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