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Housing Market Fluctuations in a Life-Cycle Economy with Credit Constraints

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Abstract

This paper presents a first step towards a new theory of housing market fluctuations. We develop a life-cycle model where agents face credit constraints and their housing consumption is restricted to a discrete set of possibilities. The market interaction of young credit constrained agents climbing the property ladder with old agents trading down, generates co-movements of aggregate house prices, volume of transactions and income, consistent with the patterns observed in the U.S and the UK Under plausible assumptions the model reproduces the slight lead of transaction volume over the other two series as documented in the data. Our theory asserts that the fluctuations in housing prices depend crucially on fluctuation in the current income of young household the first-time buyers). Thus, it sheds light on why housing prices are more volatile than GDP, and why they exhibit some degree of predictability in a market where households optimise over the timing of their transaction.

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  • Sven Rady, 1998. "Housing Market Fluctuations in a Life-Cycle Economy with Credit Constraints," FMG Discussion Papers dp296, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp296
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    1. Peter Linneman & Susan Wachter, 1989. "The Impacts of Borrowing Constraints on Homeownership," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 17(4), pages 389-402.
    2. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    3. Grossman, Sanford J & Laroque, Guy, 1990. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," Econometrica, Econometric Society, vol. 58(1), pages 25-51, January.
    4. Ortalo-Magne, Francois & Rady, Sven, 1999. "Boom in, bust out: Young households and the housing price cycle," European Economic Review, Elsevier, vol. 43(4-6), pages 755-766, April.
    5. DiPasquale Denise & Wheaton William C., 1994. "Housing Market Dynamics and the Future of Housing Prices," Journal of Urban Economics, Elsevier, vol. 35(1), pages 1-27, January.
    6. Jeremy C. Stein, 1995. "Prices and Trading Volume in the Housing Market: A Model with Down-Payment Effects," The Quarterly Journal of Economics, Oxford University Press, vol. 110(2), pages 379-406.
    7. Ioannides, Yannis M., 1989. "Housing, other real estate, and wealth portfolios : An empirical investigation based on the 1983 Survey of Consumer Finances," Regional Science and Urban Economics, Elsevier, vol. 19(2), pages 259-280, May.
    8. Duca, John V. & Rosenthal, Stuart S., 1994. "Borrowing constraints and access to owner-occupied housing," Regional Science and Urban Economics, Elsevier, vol. 24(3), pages 301-322, June.
    9. Jones, Lawrence D., 1997. "The Tenure Transition Decision For Elderly Homeowners," Journal of Urban Economics, Elsevier, vol. 41(2), pages 243-263, March.
    10. Green, Richard & Hendershott, Patric H., 1996. "Age, housing demand, and real house prices," Regional Science and Urban Economics, Elsevier, vol. 26(5), pages 465-480, August.
    11. Lawrence D. Jones, 1989. "Current Wealth and Tenure Choice," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 17(1), pages 17-40.
    12. Engelhardt, Gary V, 1996. "Consumption, Down Payments, and Liquidity Constraints," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(2), pages 255-271, May.
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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand

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