A Dynamic Structural Model of Housing Demand: Estimation and Policy Implications

with Patrick Bajari, Phoebe Chan, and Dirk Krueger

abstract

In the U.S., macroeconomic policy makers are concerned about how consumers will respond to falling nominal home prices, rising mortgage interest rates and tightening credit standards.  In order to address these questions, we estimate and simulate a dynamic structural model of housing demand.  In the model, consumers maximize expected discounted lifetime utility from housing services and a composite commodity.  The model allows for realistic features of the housing market including non-convex adjustment costs from buying and selling a home and credit constraints from minimum down payment requirements.  We use the forward simulation procedure of Bajari, Benkard, and Levin (2007) to estimate the structural parameters using data from the Panel Study of Income Dynamics.  Given the estimated model parameters, we simulate the partial equilibrium response by consumers to a home price collapse, rising mortgage interest rates, and increased down payment requirements.  The simulation results show that many households do not alter their housing or non-housing consumption in response to these shocks.  The intuition behind this result is simple -- most adult households only move two or three times before retirement.   However, households that are hit by a negative income shock at the same time do make a downward adjustment to both housing and non-housing consumption.  Such households are forced to sell and downsize their current home because of credit constraints which require borrowers to maintain a minimum amount of equity in their home.