INTERACTIONS, NEIGHBORHOOD SELECTION AND HOUSING DEMAND1

This paper contributes to the growing literature that identifies and measures the impact of social context on individual economic behavior. We develop a model of housing demand with neighborhood effects and neighborhood choice. Modelling neighborhood choice is of fundamental importance in estimating and understanding endogenous and exogenous neighborhood effects. That is, to obtain unbiased estimates of neighborhood effects, it is necessary to control for non-random sorting into neighborhoods. Estimation of the model exploits a unique data set of household data that has been augmented with contextual information at two different levels (“scales”) of aggregation. One is at the neighborhood cluster level, of about ten neighbors, with the data coming from a special sample of the American Housing Survey. A second level is the census tract to which these dwelling units belong. Tract-level data are available in the Summary Tape Files of the decennial Census data. We merge these two data sets by gaining access to confidential data of the U.S. Bureau of the Census. Our results for the neighborhood choice model indicate that individuals prefer to live near others like themselves. Our estimates of the housing demand equation do confirm that neighborhood effects are important. Neighborhood choice appears to be associated with the following differences, when it is accounted for relative to when it is not, as in earlier work. First, there is a smaller endogenous social effect: the elasticity of housing demand with respect to mean neighbors’ demand is 0.6244 instead of 0.660 in earlier work. Second, there is a larger contextual effect: the elasticity of housing demand with respect to mean neighbors’ income is 0.2600 instead of 0.175. JEL Classification Codes: R21, C31.