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Endogenous Market Segmentation and the Volatility of House Prices

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  • Julia Thomas

    (Ohio State University)

  • Aubhik Khan

    (Ohio State University)

Abstract

We study an economy where households face transactions costs of participating in the housing market. In response to these costs, households choose to buy and sell houses infrequently. This, in turn, implies that the value of the typical transaction is large relative to income. In this way our model captures two essential features of household-level adjustments to residential capital. Moreover, it implies that, in any period, only a fraction of households are active in the housing market, and that this fraction evolves with the aggregate state of the economy. We find that this endogenous market segmentation amplifies and propagates the response in the relative price of housing following aggregate and sectoral shocks. Because those households currently active in the real estate market must absorb changes to the aggregate housing stock in equilibrium, market segmentation exacerbates changes in house prices. Moreover, it implies large and persistent changes in the distribution of households following an aggregate shock, which themselves cause additional movements in prices. Thus households' optimal (S,s) policies, driven by nonconvex transactions costs, not only induce lumpy adjustment at the individual level, but also explain a nontrivial fraction of observed excess price volatility in real estate markets.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 1127.

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Date of creation: 2009
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Handle: RePEc:red:sed009:1127

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  1. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & José-Víctor Ríos-Rull, 2007. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Econometrica, Econometric Society, vol. 75(6), pages 1525-1589, November.
  2. Morris A. Davis, 2010. "housing and the business cycle," The New Palgrave Dictionary of Economics, Palgrave Macmillan.
  3. Matteo Iacoviello & Marina Pavan, 2011. "Housing and Debt over the Life Cycle and over the Business Cycle," Working Papers 2011/04, Economics Department, Universitat Jaume I, Castellón (Spain).
  4. Fran�ois Ortalo-Magné & Sven Rady, 2006. "Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraints ," Review of Economic Studies, Oxford University Press, vol. 73(2), pages 459-485.
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