We empirically document large increases in financial wealth and housing wealth/income
ratios of urban Chinese households between 1995 and 2002. We analyze the drivers
behind these trends with the help of a quantitative model. Our focus is on the institutional
changes that the urban housing market experienced following the 1994 housing
reform, in particular the introduction of mortgage markets and the introduction of a
large private housing market replacing the allocation of housing through state-owned
enterprises. We find that the introduction of mortgages as well as the introduction
of private housing markets are important, the latter by resolving misallocation that
is present in the pre-reform allocation of dwellings, which distorts households’ optimal
choices. We conclude that the interaction between institutional changes and an increase
in earnings uncertainty can only partly explain the data trends. The large rise in the
housing wealth/income ratio suggests that urban Chinese households now also attach
more value of owning a house than they did two decades ago.