This paper studies a quantitative general equilibriummodel of the housing market where a large number of overlapping generations of homeowners face both idiosyncratic and aggregate risks but have limited opportunities to insure against these risks due to incomplete financial markets and collateralized borrowing constraints. Interest rates in the model, like housing and equity returns, are determined endogenously from a market clearing condition. The model has two key elements not previously considered in existing quantitative macro studies of housing finance: aggregate business cycle risk, and a realistic wealth distribution driven in the model by bequest heterogeneity in preferences. These features of the model play a crucial role in the following results. First, a relaxation of financing constraints leads to a large boom in house prices. Second, the boom in house prices is entirely the result of a decline in the housing risk premium. Third, low interest rates cannot explain high home values.

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The last fifteen years have been marked by a dramatic boom-bust cycle in real estate prices, accompanied by economically large fluctuations in international capital flows. We argue that changes in international capital flows played, at most, a small role in driving house price movements in this episode and that, instead, the key causal factor was a financial market liberalization and its subsequent reversal. Using observations on credit standards, capital flows, and interest rates, we find that a bank survey measure of credit supply, by itself, explains 53 percent of the quarterly variation in house price growth in the U.S. over the period 1992-2010, while it explains 66 percent over the period since 2000. By contrast, once we control for credit supply, various measures of capital flows, real interest rates, and aggregate activity-collectively-add less than 5% to the fraction of variation explained for these same movements in home values. Credit supply retains its strong marginal explanatory power for house price movements over the period 2002-2010 in a panel of international data, while capital flows have no explanatory power.

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Over the last 25 years, labor income inequality has increased significantly; one may expect this would lead to significant increases in wealth and consumption inequality. However the increase in wealth inequality has been relatively moderate and consumption inequality has barely increased at all. At the same time, stock market participation has increased and the equity premium has declined. I solve a general equilibrium model to show that there is an intimate link between market participation and inequality. When wage inequality increases without a change to participation costs, the model predicts large increases in wealth and consumption inequality and a drop in market participation. However, if in addition, participation costs fall to match the increase in participation observed in the data, the model predicts changes in wealth and consumption inequality quantitatively similar to those observed in the data, as well as a large decline in the equity premium.