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Learning and the Market for Housing (pdf)

Job market paper, October 2013

This paper explores a puzzling feature of the financial crisis of 2007–2009: unlike asset prices in capital markets, house prices declined steadily for over five years following the onset of the crisis. House prices evolve slowly, and this paper provides an explanation for such inertia: it takes housing market participants time to recognize a persistent boom or recession, and such gradual learning results in sluggish house price dynamics. I develop a general equilibrium model with the market for housing and mortgages; introduce uncertainty regarding the persistence of economic growth, and conduct a maximum likelihood estimation to evaluate the model's performance against the data. I show that this type of uncertainty improves the performance of the model, and I attribute this improvement to the fact that uncertainty allows the model to better account for the low-frequency range of dynamics of house prices and other observable variables.

Term Structure of Sovereign Debt in Emerging Economies

Work in progress

Broner, Lorenzoni, and Schmukler (2013) find that, for emerging economies, the short-term debt is always cheaper than the long-term debt, and even more so when the economy is in a recession. Because the governments of emerging economies tend to borrow short term in bad times, it suggests a change on the supply side. To explain how a recession can create this change, I develop a model of a small open economy that can issue bonds with different maturities and strategically default. I entertain two possible scenarios. First, an emerging economy is more likely to experience shocks to trend (Aguiar and Gopinath, 2004): due to a negative shock, investors anticipate a high chance of default in the near future, and an even higher one in the long run. Second, investors may prefer the uncertainty about the future return to resolve quickly: even when the shock is transitory, it results in higher—albeit gradually diminishing—chance of default for several periods into the future, and investors face higher uncertainty about the return on debt. These scenarios can explain why investors prefer short-term bonds during the recessions.

Optimism in the Market for Mortgages: a Bliss for Lenders?

Work in progress

I extend my work 'Learning and the Market for Housing', which finds that unexpectedly long recession hurts borrowers in the mortgage market. At the onset of a recession, households over-optimistically bet on continued housing boom in the near future; as a result, the housing demand and the scope of mortgage lending remain high. Eventually, households learn that the recession is long, which results in a drop in house price and a high default rate on mortgages that prove to be oversized ex post. Borrowers lose net worth and experience a fall in consumption and housing purchases. Savers, on the contrary, are able to use their funds to buy cheap housing and maintain consumption. In effect, the ex-post excessive optimism redistributes wealth from the borrowers to the savers. I design a model with heterogeneous households and rigorous treatment of wealth distribution and study the impact of a permanent house price decline which is initially not recognized as permanent by the households. The work has policy implications, since borrowers are protected against excessive wealth losses if the prospects of housing market are better communicated to the market participants.

© 2013 Eyno Rots

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