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

Aaron Hedlund

No 1417, Working Papers from Department of Economics, University of Missouri

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.

Keywords: housing; liquidity; search theory; credit constraints; household debt; foreclosure (search for similar items in EconPapers)
JEL-codes: D31 D83 E21 E22 G11 G12 G21 R21 R31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-dge, nep-ger, nep-mac and nep-ure
Date: 2014-09-12
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