Some Apples Fall Far: Skill Premium, Housing Indivisibility, and the Rising Price-to-Rent Ratio

Over the past decade, many advanced economies have experienced a simultaneous rise in skill premium and an increase in house prices relative to rents. This paper argue that these trends are linked through imperfect intergenerational transmission of skill. We document a persistent widening of the gap between the mean income in high and low skilled sectors in Israel, together with a steeply rising price-to-rent ratio. Then, we construct a model of heterogeneous dynasties with indivisible housing and labor income risk.
The new elements of the model are idiosyncratic risk in housing returns and long-run labor income risk due to rare skill displacement. An increasing skill premium induces more savings by high skilledworkers and due to housing indivisibility, a decline in the risk premium on housing assets, thereby increasing house prices more than rents. The model’s quantitative predictions are consistent with key empirical patterns of intergenerational mobility and the Israeli housing and labor markets.