Working Paper: CEPR ID: DP6932
Authors: Oscar Arce; David J. López-Salido
Abstract: 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 Codes: G21; R21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tighter collateral constraints (E51) | Emergence of Housing Bubbles (R31) |
| Initial state of the economy (E32) | Transition Between Regimes (P39) |
| Funding shocks (E44) | Transition Between Regimes (P39) |
| Type of bubble (E32) | Welfare Implications (D69) |