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Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraints

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  • FRAN�OIS ORTALO-MAGN�
  • SVEN RADY

Abstract

We propose a life-cycle model of the housing market with a property ladder and a credit constraint. We focus on equilibria that replicate the facts that credit constraints delay some households' first home purchase and force other households to buy a home smaller than they would like. The model helps us identify a powerful driver of the housing market: the ability of young households to afford the down payment on a starter home, and in particular their income. The model also highlights a channel whereby changes in income may yield housing price overreaction, with prices of trade-up homes displaying the most volatility, and a positive correlation between housing prices and transactions. This channel relies on the capital gains or losses on starter homes incurred by credit-constrained owners. We provide empirical support for our arguments with evidence from both the U.K. and the U.S. Copyright 2006 The Review of Economic Studies Limited.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Review of Economic Studies.

Volume (Year): 73 (2006)
Issue (Month): 2 (04)
Pages: 459-485

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Handle: RePEc:bla:restud:v:73:y:2006:i:2:p:459-485

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