Learning about the Neighborhood: The Role of Supply Elasticity for Housing Cycles

Motivated by an intriguing observation during the recent U.S. housing cycle that counties with housing supply elasticities in an intermediate range experienced the most dramatic price booms and busts, this paper develops a model to analyze information aggregation and learning in housing markets. In the presence of pervasive informational frictions, housing prices serve as important signals in the householdsí learning of the economic strength of a neighborhood. Supply elasticity a§ects not only housing supply but also the informational noise in the price signal. Our empirical analysis also provides evidence supporting two key predictions of the model: 1) both housing price and share of secondary home purchases are most variable in areas with intermediate supply elasticities; and 2) these variances are positively correlated.