Erasmus Finance Seminar

This paper documents a strong and continuous increase in the average correlation of home price growth across US cities since the early 1980s. The average 5 year rolling correlation of home price growths increases from 0.02 to 0.40 over the 1985-2011 period. We show that this phenomenon is in large part due to the process of the mortgage market integration that occurred in the US during the period. First, we derive the appropriate measure of mortgage market integration for a city pair, which captures the extent to which lending in both cities is done by the same institutions. Second, we document that the cross section of city pair correlations is strongly related with this measure of financial integration. This statistical relationship is very strong and robust to the inclusion of city pair fixed effects and various time-varying controls, including measures of economic similarity. Second, we use bilateral cross state banking deregulations to instrument mortgage market integration in a city pair. Third, we attribute most of the increase in mortgage integration to the rise of a handful of US-wide players, among them large banks in the 1980s-1990s and pure-play originators in the 2000s. Overall, financial integration of the US mortgage market explains about 50% of the rise of the average home price correlation over the period. This is because lending in city pairs is increasingly done by the same few institution. Increased synchronization of real economic activity across city-pairs, or of lending policy across lenders, plays no role.