Housing prices propagation: A theory of spatial interactions

Abstract

A puzzle is that price-to-rent ratios in the housing market of a given urban area vary a lot in time and space. In some contexts, accounting for differences in local discount rates or rent growth differences is not sufficient. We propose a variant of asset pricing equations for housing markets that include a price gradient in space. It is analogous to the transport equation in physics and generates a new range of solutions consistent with the facts. The main rationale for the price gradient in the asset pricing equation is the existence of spatial search frictions for housing, but other informational frictions are discussed. The main mechanism is supported by the data analysis of a large urban area, Paris region.