Volatility and Liquidity in the Real Estate Market

Abstract

Empirical evidence suggests that when the market becomes increasingly volatile, trading activities may be depressed or even halted. We develop a simple model to formally study the relationship between market volatility and asset liquidity in the real estate market. It is shown that an increase in market volatility negatively affects asset liquidity when information is asymmetric between the market participants. Based on this result we propose a new theory for the brokerage function at the bargaining stage of real estate trading, namely, whether the brokers’ role is to facilitate or hinder trading hinges on whether their involvement serves to mitigate or exacerbate the problem of information asymmetry between the buyers and sellers. The result is also used to offer theoretical explanations for some empirical findings in the literature.

Keywords: market volatility, liquidity, real estate market

JEL Classification: R31, G10