What Drives the Owner-Occupied and Rental Housing Markets? Evidence from an Estimated DSGE Model

Abstract

Most DSGE models with a housing market do not explicitly include a rental market and assume a tight mapping between house prices and rents over the business cycle. However, rents are much smoother than house prices in the data. We match this feature of the data by adding both an owner-occupied housing market and a rental market with nominal rigidity in a standard DSGE model. The housing preference shock explains 35% of the variation in rents but does not contribute much to the dynamics of house prices. The intertemporal preference shock accounts for more than half of the variation in house prices and contributes significantly to residential investment fluctuations through the liquidity constraint. The monetary policy shock explains little of the fluctuations in the price-rent ratio. Nominal rigidity in rental contracts plays an important role in capturing the smoothness of rents and the large variation in the price-rent ratio.