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Interest Rate Fluctuations and Equilibrium in the Housing Market

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  • Yavuz Arslan

Abstract

I study the general equilibrium of the housing market in an economy populated by over-lapping generations of households. A contribution of the present paper is to solve for the housing market equilibrium in the presence of aggregate (interest rate) uncertainty with a realistic mortgage contract. In addition, households also face idiosyncratic uncertainty resulting from stochastic changes over the lifecycle in tastes (or need) for housing. In this environment, profit-maximizing banks offer fixed-rate mortgage (FRM) contracts to homebuyers. As seems plausible, each housing market transaction is subject to a fixed cost, which gives rise to S-s policy rules for housing transactions : existing homeowners change the size of their houses only if there is a sufficiently large change in the state of the economy (i.e., in interest rates, in their taste for housing, etc.). A plausibly calibrated version of the model is consistent with three empirically documented features of the housing market : (i) highly volatile housing prices and transaction volume, (ii) a strong positive correlation between transaction volume and housing prices, and (iii) a signi?cant negative relationship between interest rates and housing prices, which can rationalize a large part of the recent boom in housing prices in the U.S. and around the world.

Suggested Citation

  • Yavuz Arslan, 2013. "Interest Rate Fluctuations and Equilibrium in the Housing Market," Working Papers 1343, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  • Handle: RePEc:tcb:wpaper:1343
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    File URL: http://www.tcmb.gov.tr/wps/wcm/connect/EN/TCMB+EN/Main+Menu/Publications/Research/Working+Paperss/2013/13-43
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    Cited by:

    1. Fatih Guvenen, 2011. "Macroeconomics with hetereogeneity : a practical guide," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 255-326.
    2. Akkoyun, H. Cagri & Arslan, Yavuz & Kanik, Birol, 2013. "Housing prices and transaction volume," Journal of Housing Economics, Elsevier, vol. 22(2), pages 119-134.

    More about this item

    Keywords

    House prices; Interest rates; Mortgage contracts;

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G01 - Financial Economics - - General - - - Financial Crises
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand

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