US real estate inflation prediction: Exchange rates and net foreign assets

The recent housing price inflation forecasting literature has focused on the use of domestic variables for prediction of housing price inflation. However, around 7% of all US housing sales are attributed to international buyers; a potentially important market force. Further, international finance theory finds a role for foreign savings shocks in causing the housing price bubble of the last decade. Under floating exchange rate regimes, the Dornbusch model predicts shocks to domestic or foreign economies will be reflected in exchange rates. When exchange rates are fixed, shocks are likely to affect the net foreign asset holdings. In this study, I examine the role of exchange rates returns and the net change in foreign asset holdings in improving US real estate inflation forecasts. I conduct in-sample and out-of-sample comparison of forecasting models relative to an autoregressive baseline model. I find that the inclusion of foreign sector variables can improve the US real estate inflation forecasts by up to 40%. This improvement is mostly driven by changes in the net foreign asset holdings at longer horizons. The results are robust to samples at the metropolitan level although with different gains.