Collateral Constraints, Wealth Effects, and Volatility: Evidence from Real Estate Markets
We document that, within-region, lower-income zip codes have more volatile returns to housing than do higher-income zip codes, without any corresponding higher returns. We rationalize this finding with a simple model that features a collateral constraint on borrowing and non-homothetic preferences over housing. Shocks to the representative household’s income lead to volatility in the return to housing via the collateral constraint, and this volatility is decreasing in the average level of income, consistent with our empirical findings. We provide further evidence for our mechanism using (1) variation in wealth induced by lagged housing returns; (2) cross-sectional data on the housing expenditure share; and (3) state-level non-recourse status, which instruments for the tightness of collateral constraints. Finally, we observe that endogenous volatility in housing returns may limit the available supply of housing, via producers’ option to delay. Consistent with this hypothesis, the volatility of new permit issuance and the age of the housing stock are both monotonically decreasing in local income levels.