Natural Expectations and Home Equity Extraction
53 Pages Posted: 18 Feb 2015
Date Written: October 23, 2014
In this paper we show that long-run expectations about future housing prices of both households and, especially, financial intermediaries had a large impact on households' indebtedness during the recent boom in U.S. housing prices. We introduce the theory of natural expectations in a collateralized credit market model populated by households and banks and find: (1) that mild variations in long-run forecasts of housing prices result in large differences in the amount of home equity extracted during the boom; and (2) that the equilibrium level of debt and the interest rate are particularly sensitive to financial intermediaries' naturalness.
Keywords: natural expectations, home equity extraction, consumption/saving decision, housing price
JEL Classification: E21, E32, E44, D84
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