A Theory of Housing Demand Shocks

Liu, Zheng; Wang, Pengfei; Zha, Tao

doi:10.29338/wp2019-04

Working Paper

A Theory of Housing Demand Shocks

Abstract: Aggregate housing demand shocks are an important source of house price fluctuations in the standard macroeconomic models, and through the collateral channel, they drive macroeconomic fluctuations. These reduced-form shocks, however, fail to generate a highly volatile price-to-rent ratio that comoves with the house price observed in the data (the ?price-rent puzzle?). We build a tractable heterogeneous-agent model that provides a microeconomic foundation for housing demand shocks. The model predicts that a credit supply shock can generate large comovements between the house price and the price-to-rent ratio. We provide empirical evidence from cross-country and cross-MSA data to support this theoretical prediction.

Keywords: price-rent puzzle; heterogeneity; marginal agent; cutoff point; liquidity premium; price-to-rent ratio; collateral constraints;

JEL Classification: E21; E44; G21;

https://doi.org/10.29338/wp2019-04