Endogenous gentrification and housing price dynamics

"In this paper, we explore differential changes in house prices across neighborhoods within a city to better understand the nature of house price dynamics across cities. First, we document in detail that there is substantial and systematic heterogeneity in house price dynamics within a city during city wide housing price booms and busts. Second, we propose a new model of within city house price dynamics that is consistent with the empirical facts. We assume that there is a positive neighborhood externality: people like to live close to richer neighbors. We show that there is an equilibrium where households fully segregate based on their income. In response to positive housing demand shocks, the model predicts that the poor neighborhoods on the boundary with the rich ones are the most price elastic. We refer to this process as gentrification. We then empirically test this new mechanism against other mechanisms that could explain within city house price differences. We find strong support for the existence of endogenous gentrification in explaining housing price dynamics within a city. Finally, we show that even after controlling for other important determinants of land prices, the endogenous gentrification mechanism is still important in explaining cross city differences in house price dynamics"--National Bureau of Economic Research web site.