Illiquidity and its Discontents: Trading Delays and Foreclosures in the Housing Market

Year: 
2014
Working Paper Number: 
WP 14-17
Abstract: 

This paper investigates the macroeconomic effects of search risk in the housing
market. To do so, I introduce a tractable directed search model of housing with mul-
tidimensional buyer and seller heterogeneity. I incorporate this framework in an in-
complete markets macroeconomic model with long-term mortgages and equilibrium
default. I show that search risk spills over into higher foreclosure risk by creating a
debt overhang problem. Heavily indebted sellers post high selling prices, take a long
time to sell, and frequently end up in foreclosure. As a result, search risk increases
mortgage default premia and tightens credit constraints, thus exacerbating the debt
overhang problem by making refinancing more difficult. This mechanism establishes a
novel link between housing and mortgage markets based on the illiquidity of housing.

JEL Codes: 
D31, D83, E21, E22, G11, G12, G21, R21, R31
Authors: 
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