Measuring risk on investment in informal (illegal) housing: Theory and evidence from Pune, India

In this paper we analyze a household's decision to invest in informal (illegal) housing in developing countries. Using a simple model of housing supply, we show that the difference in the rates of return on housing investment in the formal and informal sectors reflects the additional risk associated with the latter. Using household survey data from Pune (a large city in India), we estimate this risk premium in the city to be approximately 22%, or 150 basis points. We use our approach to estimate the informal risk premium for cities in other countries based on results from previous studies.