Journal Article

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

François Ortalo-Magné and Sven Rady

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 73, issue 2, pages 459-485
Published in print April 2006 | ISSN: 0034-6527
Published online April 2006 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2006.383_1.x
Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraints

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  • Housing Markets, Production Analysis, and Business Location
  • Intertemporal Choice and Growth

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We propose a life-cycle model of the housing market with a property ladder and a credit constraint. We focus on equilibria that 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 overreaction, 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.

Keywords: D91; R31

Journal Article.  14795 words.  Illustrated.

Subjects: Housing Markets, Production Analysis, and Business Location ; Intertemporal Choice and Growth

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