House Prices, Rents and Interest Rates Under Collateral Constraints

42 Pages Posted: 2 Aug 2006

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: May 2006


We develop an OLG model aimed at explaining the joint determination of housing prices, rents, and interest rates, in an environment featuring a positive home ownership bias and individual borrowing limits that generate a mismatch between desired and available funds to finance housing purchases. Individual heterogeneity on this mismatch gives rise to three different types of households: renters, landlords (i.e. buy-to-let investors, who provide the stock of houses for rent) and homebuyers who do not participate in the rental market. We investigate the conditions under which two alternative stationary equilibria may coexist: (i) a low valuation equilibrium (LVE) in which landlords do not exhaust their borrowing limits; and (ii) a high valuation one (HVE) where every household is financially constrained at the time of purchasing its housing stock. In a HVE (relative to the LVE) the volume of buy-to-let investment, the price-to-rent ratio and the housing price are higher while the interest rate is lower. Due to binding borrowing constraints, in a HVE further reductions in the interest rate only bear a positive networth effect through a reduction of the cost of repaying outstanding mortgaged debt, which fuels future availability of funds, thus sustaining the higher demand for credit. More generally, coexistence of both types of equilibria provides a rationale for the existence of speculative paths from a LVE to a HVE.

Keywords: Price-to-rent ratio, collateral constraints, buy-to-let investment, multiple equilibria

JEL Classification: G21, R21, R31

Suggested Citation

Arce, Oscar and Lopez-Salido, David, House Prices, Rents and Interest Rates Under Collateral Constraints (May 2006). CEPR Discussion Paper No. 5689. Available at SSRN:

Oscar Arce

Banco de España ( email )

Alcala 50
Madrid 28014

David Lopez-Salido (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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

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