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Heterogeneity within Communities: A Stochastic Model with Tenure Choice

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  • Ortalo-Magné, François
  • Rady, Sven

Abstract

Standard explanations for the income heterogeneity within neighborhoods rely on differences of preferences across households and heterogeneity of the housing stock. We propose an alternative and complementary explanation. We construct a stochastic equilibrium sorting model where (1) income is the sole dimension of household heterogeneity, (2) households form state-contingent housing location plans that may involve moves over their lifetimes, (3) households choose whether to own or rent depending on the housing expenditure risk associated with each tenure mode, and (4) there is a probability that newcomer households move in and compete for homes with native households. Income mixing within neighborhood arises for two reasons. First, allowing natives to form state-contingent housing location plans breaks the indivisibility of housing consumption implicit in the literature where households choose their location once and for all. Second, natives can insure themselves against rent fluctuations by buying their home prior to the realization of the population shock; newcomers cannot. As a result, poorer natives stay in the more desirable communities and only richer newcomers move in these communities. Evidence from U.S. metropolitan areas supports the effects predicted by the model.

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Bibliographic Info

Paper provided by Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems with number 49.

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Date of creation: May 2005
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Handle: RePEc:trf:wpaper:49

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Keywords: Equilibrium Sorting; Income Mixing; Housing Demand; Tenure Choice;

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Citations

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Cited by:
  1. Martín Gonzalez-Eiras & Dirk Niepelt, 2005. "Sustaining Social Security," CESifo Working Paper Series 1494, CESifo Group Munich.
  2. Markus Haavio & Heikki Kauppi, 2006. "House price fluctuations and residential sorting," 2006 Meeting Papers, Society for Economic Dynamics 774, Society for Economic Dynamics.
  3. Joseph Gyourko & Christopher Mayer & Todd Sinai, 2006. "Superstar Cities," NBER Working Papers 12355, National Bureau of Economic Research, Inc.
  4. Pablo Casas-Arce & Albert Saiz, 2006. "Owning versus leasing: do courts matter?," Working Papers 06-21, Federal Reserve Bank of Philadelphia.
  5. François Ortalo-Magné & Andrea Prat, 2005. "The Political Economy of Housing Supply," Levine's Bibliography 122247000000000954, UCLA Department of Economics.
  6. Hilber, Christian A. L. & Liu, Yingchun, 2007. "Explaining the Black-White Homeownership Gap: The Role of Own Wealth, Parental Externalities and Locational Preferences," MPRA Paper 5136, University Library of Munich, Germany.
  7. Patrick Bayer & Robert McMillan & Alvin Murphy & Christopher Timmins, 2011. "A Dynamic Model of Demand for Houses and Neighborhoods," NBER Working Papers 17250, National Bureau of Economic Research, Inc.

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