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A model of price swings in the housing market

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Author Info

  • Carlos Garriga
  • Rodolfo E. Manuelli
  • Adrian Peralta-Alva

Abstract

In this paper we use a standard neoclassical model supplemented by some frictions to understand large price swings in the housing market. We construct a two good general equilibrium model in which housing is a composite good produced using structures and land. We revisit the connection between changes in interest rates, credit conditions as measured by maximum loan-to-value ratios and expectations in influencing housing prices in a setting in which the stock of housing can be used as collateral for borrowing and credit markets are segmented. We find that changes in interest rates and credit conditions can generate significant price swings. Under rational expectations (perfect foresight) our model is able to explain 50% of the recent movements in U.S. house prices. When we allow shocks to expectations, the model’s ability to match the evidence increases significantly. Contrary to conventional wisdom, we show that standard asset pricing formulas seem to correctly describe the behavior of house prices if the appropriate pricing kernel is used.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2012-022.

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Date of creation: 2012
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Handle: RePEc:fip:fedlwp:2012-022

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Related research

Keywords: Mortgages ; Housing - Prices;

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References

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  1. Klaus Adam & Pei Kuang & Albert Marcet, 2012. "House Price Booms and the Current Account," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 77 - 122.
  2. Nobuhiro Kiyotaki & Alexander Michaelides & Kalin Nikolov, 2011. "Winners and Losers in Housing Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 255-296, 03.
  3. Davis, Morris & Heathcote, Jonathan, 2001. "Housing and the Business Cycle," Working Papers 01-09, Duke University, Department of Economics.
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Cited by:
  1. Mary C. Daly & Bart Hobijn, 2013. "Downward nominal wage rigidities bend the Phillips curve," Working Paper Series 2013-08, Federal Reserve Bank of San Francisco.
  2. Alejandro Justiniano & Giorgio Primiceri & Andrea Tambalotti, 2013. "Household leveraging and deleveraging," Staff Reports 602, Federal Reserve Bank of New York.
  3. Michele Boldrin & Carlos Garriga & Adrian Peralta-Alva & Juan M. Sánchez, 2013. "Reconstructing the great recession," Working Papers 2013-006, Federal Reserve Bank of St. Louis.
  4. Narayan Bulusu & Jefferson Duarte & Carles Vergara-Alert, 2013. "Booms and Busts in House Prices Explained by Constraints in Housing Supply," Working Papers 13-18, Bank of Canada.

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