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Endogenous housing risk in an estimated DSGE model of the Euro Area

Author(s): Beatrice Pataracchia, Rafal Raciborski, Marco Ratto, Werner Roeger

Endogenous housing risk in an estimated DSGE model of the Euro Areapdf(896 kB) Choose translations of the previous link  

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The paper provides an extension to first generation DSGE models with a financial sector – for which QUEST III would be a typical example – by explicitly modelling (mortgage) loan demand and supply decisions.

We estimate a DSGE model with a housing sector where housing capital is used as collateral against which impatient consumers borrow from more patient lenders. While in existing estimated models with a construction sector the Loan-to-Value (LTV) ratio is imposed exogenously and constant (e.g., Iacoviello and Neri, 2010, In’t Veld et al., 2011), we introduce an endogenous LTV ratio by explicitly modelling the riskiness of loans in order to capture changing credit conditions. Using data of the Euro Area, we show that, compared to similar models with an exogenous LTV ratio, the business cycle properties of our model improve. The endogenous default mechanism allows estimating an important amplification mechanism driven by the riskiness of collateral values and propagating, in turn, into the real economy. Housing market-related shocks appear to be the main driver of the pre-crisis growth of mortgage-backed loans and a subsequent reversal of the sentiment on the housing market may have been a trigger that led to a credit crunch, house price bubble burst and a collapse in the construction sector. Shocks on the housing market had also a substantial impact on several demand aggregates, in particular, consumption.

(European Economy. Economic Papers 505. October 2013. Brussels. PDF. 72pp. Tab. Bibliogr. Free.)

KC-AI-13-505-EN-N (online)
ISBN 978-92-79-32332-4 (online)
doi: 10.2765/54387 (online)

Economic Papers are written by the staff of the Directorate-General for Economic and Financial Affairs, or by experts working in association with them. The Papers are intended to increase awareness of the technical work being done by staff and to seek comments and suggestions for further analysis. The views expressed are the author’s alone and do not necessarily correspond to those of the European Commission.

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