Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraint

Ortalo-Magné, François and Rady, Sven (May 2005): Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraint. SFB/TR 15 Discussion Paper No. 50

Abstract

We propose a life-cycle model of the housing market with a property ladder and a credit constraint. We focus on equilibria which replicate the facts that credit constraints delay some households' first home purchase and force other households to buy a home smaller than they would like. The model helps us identify a powerful driver of the housing market: the ability of young households to afford the down payment on a starter home, and in particular their income. The model also highlights a channel whereby changes in income may yield housing price overshooting, with prices of trade-up homes displaying the most volatility, and a positive correlation between housing prices and transactions. This channel relies on the capital gains or losses on starter homes incurred by credit-constrained owners. We provide empirical support for our arguments with evidence from both the U.K. and the U.S.

• Item Type: Paper
• Keywords: Housing Demand, Income Fluctuations, Overlapping Generations, Collateral Constraint
• Faculties: Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems; Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems > A4 - Unvollständige Verträge, Marktinteraktion und soziale Vergleichsprozesse; Economics; Economics > Chairs > Chair of Dynamic Economic Theory (closed)
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: E32, G12, G21, R21
• Language: English