DP3015 Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraints

Author(s): François Ortalo-Magné, Sven Rady
Publication Date: October 2001
Keyword(s): credit constraints, financial liberalization, housing prices and transactions, income shocks, overlapping generations
JEL(s): E32, G12, G21, R21
Programme Areas: International Macroeconomics, Financial Economics, Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3015

This Paper presents a dynamic theory of housing market fluctuations. It develops a life-cycle model where households are heterogeneous with respect to income and preferences, and mortgage lending is restricted by a down-payment requirement. The market interaction of young credit-constrained households with older or richer unconstrained households generates the following results. (1) Current income of young credit-constrained households affects housing prices independently of aggregate income. (2) Housing prices and the number of housing transactions are positively correlated. (3) Housing prices over-react to income shocks. (4) A relaxation of the down-payment constraint triggers a boom-bust cycle. These results are consistent with patterns observed in the US and the UK.