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http://ssrn.com/abstract=1602163
 
 

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The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk-Sharing in General Equilibrium


Jack Favilukis


London School of Economics & Political Science (LSE)

Sydney C. Ludvigson


New York University - Department of Economics; National Bureau of Economic Research (NBER)

Stijn Van Nieuwerburgh


New York University Stern School of Business, Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

October 15, 2013


Abstract:     
This paper studies the role of time-varying risk premia as a channel for generating and propagating fluctuations in housing markets, aggregate quantities, and consumption and wealth heterogeneity. We study a two-sector general equilibrium model of housing and non-housing production where heterogeneous households face limited opportunities to insure against aggregate and idiosyncratic risks. The model generates large variability in the national house price-rent ratio, both because it fluctuates endogenously with the state of the economy and because it rises in response to a relaxation of credit constraints and decline in housing transaction costs (financial market liberalization). These factors, together with a rise in foreign ownership of U.S. debt calibrated to match the actual increase over the period 2000-2006, generate fluctuations in the model price-rent ratio that explain between 80 and 100 percent of the increase in the national price-rent observed in U.S. data over this period. The model also predicts a sharp decline in home prices starting in 2007, driven by the economic contraction and by a presumed reversal of the financial market liberalization. Fluctuations in the model's price-rent ratio are driven by changing risk premia, which fluctuate endogenously in response to cyclical shocks, the financial market liberalization, and its subsequent reversal. By contrast, we show that the inflow of foreign money into domestic bond markets plays a small role in driving home prices, despite its large depressing influence on interest rates. Finally, the model implies that procyclical increases in equilibrium price-rent ratios reflect rational expectations of lower future housing returns, not higher future rents.

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Date posted: May 10, 2010 ; Last revised: October 17, 2013

Suggested Citation

Favilukis, Jack and Ludvigson, Sydney C. and Van Nieuwerburgh, Stijn, The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk-Sharing in General Equilibrium (October 15, 2013). Available at SSRN: http://ssrn.com/abstract=1602163 or http://dx.doi.org/10.2139/ssrn.1602163

Contact Information

Jack Favilukis
London School of Economics & Political Science (LSE) ( email )
Houghton Street
London, WC2A 2AE
United Kingdom
Sydney C. Ludvigson
New York University - Department of Economics ( email )
19 West 4th Street, 6th floor
New York, NY 10012
United States
212-998-8927 (Phone)
212-995-4186 (Fax)
HOME PAGE: http://www.econ.nyu.edu/user/ludvigsons/
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Stijn Van Nieuwerburgh (Contact Author)
New York University Stern School of Business, Department of Finance ( email )
44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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