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Endogenous Market Segmentation and the Volatility of House Prices

  • Julia Thomas

    (Ohio State University)

  • Aubhik Khan

    (Ohio State University)

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

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Date of creation: 2009
Date of revision:
Handle: RePEc:red:sed009:1127
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. Aubhik Khan & Julia K. Thomas, 2007. "Idiosyncratic shocks and the role of nonconvexities in plant and aggregate investment dynamics," Working Papers 07-24, Federal Reserve Bank of Philadelphia.
  2. Ortalo-Magné, François & Rady, Sven, 2001. "Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraints," CEPR Discussion Papers 3015, C.E.P.R. Discussion Papers.
  3. John Y. Campbell & Joao F. Cocco, 2004. "How Do House Prices Affect Consumption? Evidence From Micro F. Data," Harvard Institute of Economic Research Working Papers 2045, Harvard - Institute of Economic Research.
  4. Reinhart, Carmen & Ogaki, Masao, 1995. "Measuring intertemporal substitution: The role of durable goods," MPRA Paper 13690, University Library of Munich, Germany.
  5. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing and the General Equilibrium Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 655-690.
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