Arbitrage in Housing Markets

Urban economists understand housing prices with a spatial equilibrium approach that assumes people must be indifferent across locations. Since the spatial no arbitrage condition is inherently imprecise, other economists have turned to other no arbitrage conditions, such as the prediction that individuals must be indifferent between owning and renting. This paper argues these non-spatial, no arbitrage conditions are difficult to use empirically for many reasons. Owned homes are extremely different from rental units and owners are quite different from renters. The unobserved costs of home owning such as maintenance are quite large, inducing added imprecision into financial noarbitrage conditions. Furthermore, risk aversion and the high volatility of housing pries compromises short-term attempts to arbitrage by delaying home buying. Hence, it may make more sense to focus on the admittedly imprecise implications of the spatial no arbitrage condition.