In this paper we investigate the inter-dependence between financial and housing markets and analyze how uncorrelated financial risk may promote an increase in housing demand and induce bubble-like behavior of residential real estate prices. We show that endogenous relative wealth concerns may play an important role in explaining the emergence and dynamics of housing price bubbles in times of technological innovation that has high level of uncertainty. We present a general equilibrium model in which house-buyers’ exposure to financial risk together with concerns about relative wealth translates into housing price volatility. Unlike other models with endogenous relative wealth concerns, our model suggests a non-monotonic relation between the technological risk and the housing price risk. Our main result is that housing price bubbles are most likely to emerge as a result of house-buyer’s financial risk exposure when this exposure is low.

In this paper we investigate the inter-dependence between financial, mortgage, and housing markets. In our paper “Investment in risky technology stocks and housing price bubbles” we presented a stylized finite-horizon stochastic model that demonstrated that increase in demand for housing may result from financial risk exposure, when house-buyers are subject to relative wealth concerns and competition over future consumption. In this paper we modify our original model by introducing mortgages. We examine patterns in the borrowing/lending market in the presence of relative wealth concerns and analyze the effects of mortgage market on the housing price dynamics. A non-monotonic relation between technological risk and housing price risk in our model suggests that high borrower’s debt-to-income ratio resulting from high housing price volatility is more likely to be high when financial exposure of lenders is low.