Interest Rate Fluctuations and Equilibrium in the Housing Market
Central Bank of Turkey
March 14, 2008
We study the general equilibrium of the housing market in an economy populated by overlapping 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 home buyers. 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 home owners 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 significant 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.
Number of Pages in PDF File: 36
Keywords: Housing Prices, Transaction Volume, Interest Rates
JEL Classification: E30, E40, E60working papers series
Date posted: June 27, 2007 ; Last revised: March 17, 2008
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