In standard production models, wage volatility is far too high, and equity volatility is far too low. A simple modification–sticky wages because of infrequent resetting together with a constant elasticity of substitution (CES) production function leads to both smoother wages and higher equity volatility. Further, the model produces several other hard-to-explain features of financial data: high Sharpe ratios, low and smooth interest rates, time-varying equity volatility and premium, a value premium, and a downward-sloping equity term structure. Procyclical, volatile wages are a hedge for firms in standard models; smoother wages act like operating leverage, making profits and dividends riskier. Received July 30, 2013; accepted July 6, 2015 by Editor Geert Bekaert.

ABSTRACT Many cities have attracted a flurry of out‐of‐town (OOT) home buyers. Such capital inflows affect house prices, rents, construction, labor income, wealth, and ultimately welfare. We develop an equilibrium model to quantify the welfare effects of OOT home buyers for the typical U.S. metropolitan area. When OOT investors buy 10% of the housing in the city center and 5% in the suburbs, welfare among residents falls by 0.61% in consumption‐equivalent units. House prices and rents rise substantially, resulting in welfare gains for owners and losses for renters. Policies that tax OOT buyers or mandate renting out vacant property mitigate welfare losses.

This paper studies a quantitative general equilibrium model of housing. 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.