Housing Bubbles

50 Pages Posted: 2 Dec 2008

See all articles by Oscar Arce

Oscar Arce

Banco de España

David Lopez-Salido

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: August 2008


In this paper we use the notion of a housing bubble as an equilibrium in which some investors hold houses only for resale purposes and not for the expectation of a dividend, either in the form of rents or utility. We provide a life-cycle model where households face collateral constraints that tie their credit capacity to the value of their houses and examine the conditions under which housing bubbles can emerge. In such equilibria, the total housing stock is held by owners that extract utility from their homes, landlords that obtain rents, and investors. We show that an economy with tighter collateral constraints is more prone to bubbles which, in turn, tend to have a larger size but are less fragile in face of fund-draining shocks. Our environment also allows for pure bubbles on useless assets. We find that multiple equilibria in which the economy moves endogenously from a pure bubble to a housing bubble regime and vice versa are possible. This suggests that high asset price volatility may be a natural consequence of asset shortages (or excess funding) that depress interest rates sufficiently so as to sustain an initial bubble. We also examine some welfare implications of the two types of bubbles and discuss some mechanisms to rule out equilibria with housing bubbles.

Keywords: buy-to-let investment, collateral constraints, housing bubbles, switching

JEL Classification: G21, R21

Suggested Citation

Arce, Oscar and Lopez-Salido, David, Housing Bubbles (August 2008). CEPR Discussion Paper No. DP6932. Available at SSRN: https://ssrn.com/abstract=1307522

Oscar Arce (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014

David Lopez-Salido

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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