How Auctions Amplify House-Price Fluctuations
76 Pages Posted: 17 Nov 2015 Last revised: 30 May 2020
Date Written: April 15, 2017
I develop a tractable dynamic model of the housing market where the prices are determined in auctions rather than by Nash bargaining as in the housing search model from the literature. The model with auctions mimics the actual housing markets by generating fluctuations between the booms and busts. During the boom multiple buyers compete for each house, while in the bust buyers are choosing between several available houses. The model produces highly volatile house prices, improving on the benchmark housing search model and helping to solve the puzzle of excess volatility of house prices. This high volatility arises in the auction model because of the competition between buyers with heterogeneous values. With heterogeneous values, the method of choosing the buyer among all the interested buyers becomes important for the quantitative properties of the model. In the benchmark model with Nash bargaining, the buyer is chosen randomly among all interested buyers. Then the average of buyers' house values determines the house price. In the auction model the buyer is chosen by the maximum bid among all interested buyers, so the highest value determines the house prices. During the housing booms, the highest values increase more than the average values, making the sales price more volatile. This high volatility is efficient, since the equilibrium in the model decentralizes the solution of the social planner problem, constrained by the search frictions.
Keywords: housing, real estate, volatility, search and matching, pricing, liquidity, Nash bargaining, auctions, bidding wars
JEL Classification: C78, D44, D83, E44, R21, R31
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