The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk-Sharing in General Equilibrium
This paper studies the role of time-varying risk premia as a channel for generating and propagating fluctuations in housing markets, aggregate quantities, and consumption and wealth heterogeneity. We study a two-sector general equilibrium model of housing and non-housing production where heterogeneous households face limited opportunities to insure against aggregate and idiosyncratic risks. The model generates large variability in the national house price-rent ratio, both because it fluctuates endogenously with the state of the economy and because it rises in response to a relaxation of credit constraints and decline in housing transaction costs ( financial market liberalization). These factors, together with a rise in foreign ownership of U.S. debt calibrated to match the actual increase over the period 2000-2006, generate fluctuations in the model price-rent ratio that explains a large fraction of the increase in the national price-rent ratio observed in U.S. data over this period. The model also predicts a sharp decline in home prices starting in 2007, driven by the economic contraction and by a presumed reversal of the financial market liberalization. Fluctuations in the models price-rent ratio are driven by changing risk premia, which fluctuate endogenously in response to cyclical shocks, the financial market liberalization, and its subsequent reversal. By contrast, we show that the inflow of foreign money into domestic bond markets plays a small role in driving home prices, despite its large depressing influence on interest rates. Finally, the model implies that procyclical increases in equilibrium price-rent ratios reflect rational expectations of lower future housing returns, not higher future rents. JEL: G11, G12, E44, E21.
–Jack Favilukis, LSE; Sydney C. Ludvigson, NYU and NBER; Stijn Van Nieuwerburgh, NYU NBER CEPR
Favilukis: Department of Finance, London School of Economics, Houghton Street, London WC2A 2AE; Email: email@example.com, http://pages.stern.nyu.edu/~jfaviluk. Ludvigson: Depart- ment of Economics, New York University, 19 W. 4th Street, 6th Floor, New York, NY 10012; Email: firstname.lastname@example.org; Tel: (212) 998-8927; http://www.econ.nyu.edu/user/ludvigsons/. Van Nieuwerburgh : Department of Finance, Stern School of Business, New York University, 44 W. 4th Street, 6th Floor, New York, NY 10012; Email: email@example.com; Tel: (212) 998-0673; http://pages.stern.nyu.edu/ svnieuwe/. This material is based on work supported by the National Science Foundation under Grant No. 1022915 to Ludvigson and Van Nieuwerburgh. We are grateful to Alberto Bisin, Daniele Coen-Pirani, Dean Corbae, Morris Davis, Bernard Dumas, Raquel Fernandez, Car- los Garriga, Bruno Gerard, Francisco Gomes, James Kahn, John Leahy, Chris Mayer, Jonathan McCarthy, Francois Ortalo-Magne, Stavros Panageas, Monika Piazzesi, Richard Peach, Gianluca Violante, Amir Yaron, and to seminar participants at Erasmus Rotterdam, the European Central Bank, ICEF, HEC Montreal, Lon- don School of Economics, London Business School, Manchester Business School, NYU, Stanford Economics, Stanford Finance, UCLA Finance, University of California Berkeley Finance, Université de Lausanne, Uni- versity of Michigan, University of Tilburg, University of Toronto, the University of Virginia McIntyre/Darden joint seminar, the American Economic Association annual meetings, January 2009 and January 2010, the ERID conference at Duke 2010, the London School of Economics Conference on Housing, Financial Markets, and the Macroeconomy May 18-19, 2009, the Minnesota Workshop in Macroeconomic Theory July 2009, the NBER Economic Fluctuations and Growth conference, February 2010, the European Finance Association meetings Frankfurt 2010, the NBER PERE Summer Institute meeting July 2010, the SED Montreal 2010, and the Utah Winter Finance Conference February 2010, the NBER Asset Pricing Meeting April 2011, the 2011 WFA meeting, the Baruch NYC Real Estate Meeting 2012, and the 2012 Philadephia Workshop on Macroeconomics for helpful comments. Any errors or omissions are the responsibility of the authors.