Home Ownership, Local Interactions and Segregation

Karla Hoff and Arijit Sen

No 952, Econometric Society World Congress 2000 Contributed Papers from Econometric Society

Abstract: There is substantial evidence that home-ownership changes behavior and creates local spillovers. But theoretical research on the decision to own or rent a home has ignored such spillovers and does not confront the issue of the determination of the quality and composition of neighborhoods. This paper constructs a simple theory that can explain the quality and composition of a community as the outcome of the decisions of all households in a metropolitan area, taking into account the general equilibrium effects that are inherent in the problem. We study a model with spillovers, in which the appreciation of the price of a home depends on the investments that other community residents make in their homes. We assume that capital markets are imperfect, so that it is more costly for a low-income household to purchase a home than for a high-income household to do so. We obtain two main results. First, there may be multiple, Pareto-ranked equilibria in the fraction of homeowners in a community; hence, any housing policy analysis has to recognize the problem of co-ordination failure. Second, we establish condition under which market forces will lead home-owners and renters to live in separate communities. We show that even if the poor do not have different preferences for housing than the rich and even if they internalize externalities no less than the rich do, under plausible conditions rich and poor households may live in communities that exhibit very different social characteristics- -the rich in a community with high levels of home-ownership and high levels of civic engagement, and the poor in a community with low levels of both. The model provides a framework for studying the effects on community quality of changes in the distribution of income and changes in policy towards home-ownership.

Date: 2000-08-01
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