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"In this paper, we explore differential changes in house prices across neighborhoods within a city to better understand the nature of house price dynamics across cities. First, we document in detail that there is substantial and systematic heterogeneity in house price dynamics within a city during city wide housing price booms and busts. Second, we propose a new model of within city house price dynamics that is consistent with the empirical facts. We assume that there is a positive neighborhood externality: people like to live close to richer neighbors. We show that there is an equilibrium where households fully segregate based on their income. In response to positive housing demand shocks, the model predicts that the poor neighborhoods on the boundary with the rich ones are the most price elastic. We refer to this process as gentrification. We then empirically test this new mechanism against other mechanisms that could explain within city house price differences. We find strong support for the existence of endogenous gentrification in explaining housing price dynamics within a city. Finally, we show that even after controlling for other important determinants of land prices, the endogenous gentrification mechanism is still important in explaining cross city differences in house price dynamics"--National Bureau of Economic Research web site

How do financial frictions affect the response of an economy to aggregate shocks? In this paper, we address this question, focusing on liquidity constraints and uninsurable idiosyncratic risk. We consider a search model where agents use liquid assets to smooth individual income shocks. We show that the response of this economy to aggregate shocks depends on the rate of return on liquid assets. In economies where liquid assets pay a low return, agents hold smaller liquid reserves and the response of the economy tends to be larger. In this case, agents expect to be liquidity constrained and, due to a self-insurance motive, their consumption decisions are more sensitive to changes in expected income. On the other hand, in economies where liquid assets pay a large return, agents hold larger reserves and their consumption decisions are more insulated from income uncertainty. Therefore, aggregate shocks tend to have larger effects if liquid assets pay a lower rate of return.