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Social Networks and Housing Markets

Coauthors: Mike Bailey, Ruiqing Cao and Theresa Kuchler

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We document that the recent house price experiences within an individual's social network affect her perceptions of the attractiveness of property investments, and through this channel have large effects on her housing market activity. Our data combine anonymized social network information from Facebook with housing transaction data and a survey. We first show that in the survey, individuals whose geographically-distant friends experienced larger recent house price increases consider local property a more attractive investment, with bigger effects for individuals who regularly discuss such investments with their friends. Based on these findings, we introduce a new methodology to document large effects of housing market expectations on individual housing investment decisions and aggregate housing market outcomes. Our approach exploits plausibly-exogenous variation in the recent house price experiences of individuals' geographically-distant friends as shifters of those individuals' local housing market expectations. Individuals whose friends experienced a 5 percentage points larger house price increase over the previous 24 months (i) are 3.1 percentage points more likely to transition from renting to owning over a two-year period, (ii) buy a 1.7 percent larger house, (iii) pay 3.3 percent more for a given house, and (iv) make a 7 percent larger downpayment. Similarly, when homeowners' friends experience less positive house price changes, these homeowners are more likely to become renters, and more likely to sell their property at a lower price. We also find that when individuals observe a higher dispersion of house price experiences across their friends, this has a negative effect on their housing investments. Finally, we show that these individual-level responses aggregate up to affect county-level house prices and trading volume. Our findings suggest that the house price experiences of geographically-distant friends might provide a valid instrument for local house price growth.

Do Banks Pass Through Credit Expansions to Consumers Who Want to Borrow?

Coauthors: Sumit Agarwal, Souphala Chomsisengphet and Neale Mahoney

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Chicago Booth

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We examine the ability of policymakers to stimulate household spending by reducing banks' cost of funds. Using panel data on 8.5 million credit cards and 743 credit limit regression discontinuities, we find that the one-year marginal propensity to borrow (MPB) is declining in credit score, falling from 59% for consumers with FICO scores below 660 to essentially zero for consumers with FICO scores above 740. We use the same credit limit discontinuities to estimate banks' marginal propensity to lend (MPL) out of a decrease in their cost of funds. For the lowest FICO score consumers, higher credit limits sharply reduce profits, limiting incentives to pass-through credit expansions to these consumers. We conclude that banks' MPL is lowest for those consumers with the highest MPB and discuss the implications for policies that aim to stimulate the economy through banks.

Climate Change and Long-Run Discount Rates: Evidence from Real Estate

Coauthors: Stefano Giglio, Matteo Maggiori, Andreas Weber

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The optimal investment to mitigate climate change crucially depends on the discount rate used to evaluate the investment's uncertain future benefits. The appropriate discount rate is a function of the horizon over which these benefits accrue and the riskiness of the investment. In this paper, we estimate the term structure of discount rates for an important risky asset class, real estate, up to the very long horizons relevant for investments in climate change abatement. We show that this term structure is steeply downward-sloping, reaching 2.6% at horizons beyond 100 years. We explore the implications of these new data within both a general asset pricing framework that decomposes risks and returns by horizon and a structural model calibrated to match a variety of asset classes. Our analysis demonstrates that applying average rates of return that are observed for traded assets to investments in climate change abatement is misleading. We also show that the discount rates for investments in climate change abatement that reduce aggregate risk, as in disaster-risk models, are bounded above by our estimated term structure for risky housing, and should be below 2.6% for long-run benefits. This upper bound rules out many discount rates suggested in the literature and used by policymakers. Our framework also distinguishes between the various mechanisms the environmental literature has proposed for generating downward-sloping discount rates.

House Prices, Local Demand, and Retail Prices

Revision requested at the Journal of Political Economy

Coauthor: Joseph Vavra

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VoxEU

Citylab

We use detailed micro data to document a causal response of local retail price to changes in house prices, with elasticities of 15%-20% across housing booms and busts. Notably, these price responses are largest in zip codes with many homeowners, and non-existent in zip codes with mostly renters. We provide evidence that these retail price responses are driven by changes in markups rather than by changes in local costs. We then argue that markups rise with house prices, particularly in high homeownership locations, because greater housing wealth reduces homeowners' demand elasticity, and firms raise markups in response. Consistent with this explanation, shopping data confirms that house price changes have opposite effects on the price sensitivity of homeowners and renters. Our evidence has implications for monetary, labor and urban economics, and suggests a new source of markup variation in business cycle models.

Segmented Housing Search

Revision requested at the American Economic Review

Coauthors: Monika Piazzesi and Martin Schneider

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This paper studies housing markets with multiple segments searched by heterogeneous clienteles. We document market and search activity for the San Francisco Bay Area. Variation within narrow geographic areas is large and differs significantly from variation across those areas. In particular, search activity and inventory covary positively within cities and zip codes, but negatively across those units. A quantitative search model shows how the interaction of broad and narrow searchers drives housing market activity at different levels of aggregation and shapes the response to shocks as well as price discounts due to market frictions.

Published or Forthcoming Papers

Asymmetric Information about Collateral Values

Journal of Finance, 71(2), June 2016

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[WP Version]

Appendix

VoxEU

I empirically analyze credit market outcomes when competing lenders are differentially informed about the expected return from making a loan. I study the residential mortgage market where property developers often cooperate with vertically integrated mortgage lenders to offer financing to buyers of new homes. I show that these integrated lenders have superior information about the construction quality of individual homes and exploit this information to lend against higher-quality collateral, decreasing foreclosures by up to 40%. To compensate for this adverse selection on collateral values, non-integrated lenders charge higher interest rates when competing against a better-informed integrated lender.

Government Intervention in the Housing Market - Who Wins, Who Loses?

Journal of Monetary Economics, 80, June 2016

Coauthors: Max Floetotto and Michael Kirker

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[WP Version]

Many U.S. government policies aim to encourage homeownership. We use a general equilibrium model with heterogeneous agents to consider the effects of temporary homebuyer tax credits and the asymmetric tax treatment of owner-occupied and rental housing on prices, quantities, allocations, and welfare. The model suggests that homebuyer tax credits temporarily raise house prices and transaction volumes, but have negative effects on welfare. Removing the asymmetric tax treatment of owner-occupied and rental housing can generate welfare gains for a majority of agents across steady states, but welfare impacts are substantially more varied along the transitions between steady states.

No-Bubble Condition: Model-Free Tests in Housing Markets

Econometrica, 84(3), May 2016

Coauthors: Stefano Giglio and Matteo Maggiori

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VoxEU

We test for the existence of housing bubbles associated with a failure of the transversality condition that requires the present value of payments occurring infinitely far in the future to be zero. The most prominent such bubble is the classic rational bubble. We study housing markets in the U.K. and Singapore, where residential property ownership takes the form of either leaseholds or freeholds. Leaseholds are finite-maturity, pre-paid, and tradable ownership contracts with maturities often exceeding 700 years. Freeholds are infinite-maturity ownership contracts. The price difference between leaseholds with extremely-long maturities and freeholds reflects the present value of a claim to the freehold after leasehold expiry, and is thus a direct empirical measure of the transversality condition. We estimate this price difference, and find no evidence for failures of the transversality condition in housing markets in the U.K. and Singapore, even during periods when a sizeable bubble was regularly thought to be present.

Testing for Information Asymmetries in Real Estate Markets

Review of Financial Studies, 28(4), August 2015

Coauthor: Pablo Kurlat

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[WP Version]

In housing markets, neighborhood characteristics are a key source of information heterogeneity: sellers are usually better informed about neighborhood values than buyers are, but some sellers and buyers are better informed than their peers are. Consistent with predictions from a new framework for analyzing such markets with heterogeneous assets and differentially informed agents, we find that changes in the composition of sellers toward more informed sellers and sellers with a larger supply elasticity predict subsequent house price declines. This effect is larger for houses with more price exposure to neighborhood characteristics, and smaller for houses bought by buyers that are more informed.

Very Long-Run Discount Rates

Quarterly Journal of Economics, 130(1), February 2015 (Lead Article)

Coauthors: Stefano Giglio and Matteo Maggiori

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[WP Version]

Appendix

Data Summary

Data Sets

VoxEU

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Winner Jacob Gold & Associates Best Paper Prize, ASU Sonoran Winter Finance Conference, 2014

Winner Glucksman Institute Research Prize, 2015

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We estimate how households trade off immediate costs and uncertain future benefits that occur in the very long run, 100 or more years away. We exploit a unique feature of housing markets in the U.K. and Singapore, where residential property ownership takes the form of either leaseholds or freeholds. Leaseholds are temporary, pre-paid, and tradable ownership contracts with maturities between 99 and 999 years, while freeholds are perpetual ownership contracts. The price difference between leaseholds and freeholds reflects the present value of perpetual rental income starting at leasehold expiry, and is thus informative about very long-run discount rates. We estimate the price discounts for varying leasehold maturities compared to freeholds and extremely long-run leaseholds via hedonic regressions using proprietary datasets of the universe of transactions in each country. Households discount very long-run cash flows at low rates, assigning high present value to cash flows hundreds of years in the future. For example, 100-year leaseholds are valued at more than 10% less than otherwise identical freeholds, implying discount rates below 2.6% for 100-year claims.

Regulating Consumer Financial Products: Evidence from Credit Cards

Quarterly Journal of Economics, 130(1), February 2015

Coauthors: Sumit Agarwal, Souphala Chomsisengphet and Neale Mahoney

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[WP Version]

Appendix

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We analyze the effectiveness of consumer financial regulation by considering the 2009 Credit Card Accountability Responsibility and Disclosure (CARD) Act. We use a panel data set covering 160 million credit card accounts and a difference-in-differences research design that compares changes in outcomes over time for consumer credit cards, which were subject to the regulations, to changes for small business credit cards, which the law did not cover. We estimate that regulatory limits on credit card fees reduced overall borrowing costs by an annualized 1.6% of average daily balances, with a decline of more than 5.3% for consumers with FICO scores below 660. We find no evidence of an offsetting increase in interest charges or a reduction in the volume of credit. Taken together, we estimate that the CARD Act saved consumers $11.9 billion per year. We also analyze a nudge that disclosed the interest savings from paying off balances in 36 months rather than making minimum payments. We detect a small increase in the share of accounts making the 36-month payment value but no evidence of a change in overall payments.

A Simple Framework for Estimating Consumer Benefits from Regulating Hidden Fees

Journal of Legal Studies , 43(S2), June 2014

Coauthors: Sumit Agarwal, Souphala Chomsisengphet and Neale Mahoney

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[WP Version]

Policymakers are increasingly turning to regulation to reduce hidden or non-salient fees. Yet the overall consumer benefits from these polices are uncertain because firms may increase other prices to offset lost fee revenue. We show that the extent to which firms offset reduced hidden fee revenue is determined by a simple equation that combines two "sufficient statistics," which can be estimated or calibrated in a wide range of settings: (i) a parameter that captures the degree of market competitiveness and (ii) a parameter that captures the salience of the hidden fee. We provide corroborating evidence for this approach by drawing upon evidence on the effect of fee regulation under the 2009 CARD Act. We also illustrate the applicability of our approach by using the framework to assess a hypothetical regulation of airline baggage fees.

Resource Extraction Contracts Under Threat of Expropriation: Theory and Evidence

Review of Economics and Statistics , 95(5), December 2013

Coauthor: Arthur van Benthem

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[WP Version]

VoxEU

Knowledge@Wharton

We use fiscal data on 2,468 oil extraction agreements in 38 countries to study tax contracts between resource-rich countries and independent oil companies. We analyze why expropriations occur and what determines the degree of oil price exposure of host countries. With asymmetric information about a country's expropriation cost even optimal contracts feature expropriations. Near-linearity in the oil price of real-world hydrocarbon contracts also helps to explain expropriations. We show theoretically and verify empirically that oil price insurance provided by tax contracts is increasing in a country's cost of expropriation, and decreasing in its production expertise. The timing of actual expropriations is consistent with our model.

Estimated Impact of the Fed's Mortgage-Backed Securities Purchase Program

International Journal of Central Banking , 8(2), June 2012

Coauthor: John B. Taylor

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The largest credit or liquidity program created by the Federal Reserve during the financial crisis was the mortgage-backed securities (MBS) purchase program. In this paper, we examine the quantitative impact of this program on mortgage interest rate spreads. This is more difficult than frequently perceived because of simultaneous changes in prepayment risk and default risk. Our empirical results attribute a sizeable portion of the decline in mortgage rates to such risks and a relatively small and uncertain portion to the program. For specifications where the existence or announcement of the program appears to have lowered spreads, we find no separate effect of the stock of MBS purchased by the Fed.

Older Working Papers

The Power of the Church - The Role of Roman Catholic Teaching in the Transmission of HIV

Coauthor: Arthur van Benthem

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We use the appointment of a Kenyan Roman Catholic archbishop as a natural experiment to analyze the impact of church authorities' teaching on sexual behavior. Using a triple-difference approach, we find that following the archbishop's counter-doctrinal assertion that condom use within a marriage can be acceptable to reduce HIV infections, Catholic married couples within the archdiocese who had access to condoms were 7.0 percentage points more likely to use condoms than unmarried Catholics in the diocese, non-Catholics within the diocese, or Catholics in other dioceses. These results are quantitatively large and robust to a number of econometric specifications. The evidence for whether advocating condom use leads to an increase in infidelity or a decrease in respect for women is not conclusive. Our results suggest an important role for the Catholic church in the fight against HIV. This is especially relevant in light of Pope Benedict XVI's recent reconciliatory statement about condom use.

Foreclosure and Bankruptcy - Policy Conclusions from the Current Crisis

Coauthor: Theresa Kuchler

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The recent episode of rising consumer bankruptcies and increasing foreclosure rates has sparked a lively debate about how to best tackle the crisis in the U.S. housing market. We contribute to this debate by providing an explicit model of a household's joint decision to declare Chapter 7 bankruptcy and to enter into foreclosure. This model demonstrates how bankruptcy exemption limits and mortgage regulation interact to influence consumer bankruptcy and foreclosure rates. We use state-level data to show that our model predictions are empirically plausible. We suggest that policy proposals need to focus on reducing both foreclosures and bankruptcies jointly. In particular, we argue that in the short-run a switch from non-recourse mortgages to recourse mortgages may have little effect on the number of foreclosures, but could dramatically increase the number of bankruptcies.