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Assessing High House Prices: Bubbles, Fundamentals and Misperceptions

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Author Info
Charles Himmelberg
Christopher Mayer
Todd Sinai

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Abstract

How does one tell when rapid growth in house prices is caused by fundamental factors of supply and demand and when it is an unsustainable bubble? In this paper, we explain how to assess the state of house prices--both whether there is a bubble and what underlying factors support housing demand--in a way that is grounded in economic theory. In doing so, we correct four common fallacies about the costliness of the housing market. For a number of reasons, conventional metrics for assessing pricing in the housing market such as price-to-rent ratios or price-to-income ratios generally fail to reflect accurately the state of housing costs. To the eyes of analysts employing such measures, housing markets can appear "exuberant" even when houses are in fact reasonably priced. We construct a measure for evaluating the cost of home owning that is standard for economists--the imputed annual rental cost of owning a home, a variant of the user cost of housing--and apply it to 25 years of history across a wide variety of housing markets. This calculation enables us to estimate the time pattern of housing costs within a market. As of the end of 2004, our analysis reveals little evidence of a housing bubble.

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Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 19 (2005)
Issue (Month): 4 (Fall)
Pages: 67-92
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Handle: RePEc:aea:jecper:v:19:y:2005:i:4:p:67-92

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  3. Engelhardt Gary V., 1994. "House Prices and the Decision to Save for Down Payments," Journal of Urban Economics, Elsevier, vol. 36(2), pages 209-237, September. [Downloadable!] (restricted)
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  5. Stiglitz, Joseph E, 1990. "Symposium on Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 13-18, Spring. [Downloadable!] (restricted)
  6. Stein, Jeremy C, 1995. "Prices and Trading Volume in the Housing Market: A Model with Down-Payment Effects," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 379-406, May. [Downloadable!] (restricted)
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  7. Poterba, James M, 1984. "Tax Subsidies to Owner-occupied Housing: An Asset-Market Approach," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 729-52, November. [Downloadable!] (restricted)
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  8. Patric H. Hendershott & Joel Slemrod, 1983. "Taxes and the User Cost of Capital for Owner-Occupied Housing," NBER Working Papers 0929, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Quigley, John M, 1998. "Urban Diversity and Economic Growth," Journal of Economic Perspectives, American Economic Association, vol. 12(2), pages 127-38, Spring. [Downloadable!] (restricted)
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  15. Joao Cocco, 2000. "Hedging House Price Risk With Incomplete Markets," Computing in Economics and Finance 2000 317, Society for Computational Economics.
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  18. Brueckner, Jan K., 1987. "The structure of urban equilibria: A unified treatment of the muth-mills model," Handbook of Regional and Urban Economics, in: E. S. Mills (ed.), Handbook of Regional and Urban Economics, edition 1, volume 2, chapter 20, pages 821-845 Elsevier. [Downloadable!] (restricted)
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  20. Mayo, Stephen K., 1981. "Theory and estimation in the economics of housing demand," Journal of Urban Economics, Elsevier, vol. 10(1), pages 95-116, July. [Downloadable!] (restricted)
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  22. Hanushek, Eric A & Quigley, John M, 1980. "What Is the Price Elasticity of Housing Demand?," The Review of Economics and Statistics, MIT Press, vol. 62(3), pages 449-54, August. [Downloadable!] (restricted)
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  24. Joseph Gyourko & Todd Sinai, 2003. "The Spatial Distribution of Housing-Related Ordinary Income Tax Benefits," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 31(4), pages 527-575, December. [Downloadable!] (restricted)
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  27. Engelhardt, Gary V, 1996. "Consumption, Down Payments, and Liquidity Constraints," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(2), pages 255-71, May. [Downloadable!] (restricted)
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  31. Marjorie Flavin & Takashi Yamashita, 2002. "Owner-Occupied Housing and the Composition of the Household Portfolio," American Economic Review, American Economic Association, vol. 92(1), pages 345-362, March. [Downloadable!]
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