The microstructure of housing markets [electronic resource] : search frictions and pricing mechanisms

This dissertation studies the implications of search frictions and pricing mechanisms for house prices. Many economists believe that US house prices fluctuate over time between booms and busts, and are volatile relative to fundamentals, such as rents or income in a local housing market. This excess volatility is a puzzle relative to conventional models of house prices in the literature. My dissertation aims to explain this puzzle. To explain the high volatility of house prices I substitute hypothesis of the Nash bargaining price determination, prevailing in the literature, with the auction price determination. With Nash bargaining a seller bargains with a buyer one-to-one. In practice, especially so in booms, a seller deals with multiple buyers simultaneously and sells to the highest bidder. A natural way to model this is to use an auction model. When house prices are determined in an auction instead of Nash bargaining, house prices fluctuate more, which helps explain the volatility of house prices and fluctuations between booms and busts. The dissertation consists of two related essays on the microstructure of the housing markets. The first essay explores the consequences of the pricing mechanisms for the quantitative behavior of the house prices over time in an equilibrium search model of a local housing market. The second essay asks whether the equilibrium allocations of these search models are constrained efficient. The first essay shows that the type of the pricing mechanism crucially affects the volatility of the house prices in response to the shocks to a local housing market. Specifically, if the house prices are determined in auctions rather than by one-to-one negotiation a la Nash bargaining, then the house prices are four to fifteen time more volatile if shocks to the housing market affect the participation of buyers, for example, shock to the inflow of buyers or rents. If the shocks affect the discount factor or the expectation of the housing services, then it is the opposite, that is the house prices are more volatile in the Nash bargaining model than in the auction model. Many economists agree that the housing boom-bust episode 2000-2007 was fueled by the inflow of the buyers due to the decrease in the mortgage lending standards. For these types of shocks, the auction model produces highly volatile house price growth, high enough to match the observed volatility in the local housing markets in the US. The intuition for higher volatility in the auctions as compared to the Nash bargaining comes from the differences in the outside options of the seller in the two models. The seller in the Nash bargaining model negotiates with only one buyer per period, while the seller in the auction model can meet several buyers at the same time. Thus, in the auction model the outside option of the seller is to wait till tomorrow to potentially meet several buyers, while in the Nash bargaining model the seller can enjoy a company of only one buyer. In the hot market there are many interested buyers on the market which is capitalized in the option value to sell. Because of the sensitivity of the option value to sell to the current state of the market, the house prices fluctuate more. The second essay asks whether the dynamic equilibrium model of the random search with auctions, proposed in the first essay, produces a socially efficient allocation, constrained by search frictions. The main result is that the equilibrium random search model with an auction produces an inefficient allocation. The inefficiency in the random search model comes from the monopoly power of the seller in the auction model. Buyers are visiting sellers without observing the ex-post terms of trade, and, after the meeting has occurred, the seller becomes a local monopolist, because the buyer has to incur search and waiting costs to meet another seller. The distortion can be corrected by allowing the sellers to advertise and commit to the trading mechanisms by posting the reservation price for the auction and commit to this price. Having observed these prices, the buyers then direct their search to the seller with the most attractive terms or with least competition. This alleviates the externality present in the random search model. The paper extends this result from the static setting, analyzed in the literature, to the dynamic setting.

Keywords: Economics.
Advisor: Hall Robert E. (Robert Ernest)
Piazzesi Monika primary advisor. Thesis advisor
Kurlat Pablo