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Predicting returns and rent growth in the housing market using the rent-to-price ratio: Evidence from the OECD countries

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Author Info

  • Tom Engsted

    ()
    (Aarhus University and CREATES)

  • Thomas Q. Pedersen

    ()
    (Aarhus University and CREATES)

Abstract

We investigate the predictive power of the rent-to-price ratio for future real estate returns and rent growth in 18 OECD countries over the period 1970 to 2011. First, we document that in most countries returns are signi?cantly predictable by the rent-price ratio. An increase (decrease) in the ratio signals a future increase (decrease) in returns. Second, there are large cross-country di¤erences in how the rent-price ratio predicts rent growth. For some countries the direction of predictability is negative, for other countries it is positive. Third, the predictive patterns are highly dependent on whether returns and rents are measured in nominal or real terms. Finally, there is some evidence of sub-sample instability in the predictive patterns, especially wrt. rent growth predictability. The predictability tests are conducted within a restricted VAR framework based on the dynamic Gordon growth model. This model implies restrictions across the VAR parameters that can be used to construct powerful tests of predictability.

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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2012-58.

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Length: 43
Date of creation: 17 Dec 2012
Date of revision:
Handle: RePEc:aah:create:2012-58

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Web page: http://www.econ.au.dk/afn/

Related research

Keywords: Real estate predictability; dynamic Gordon growth model; rent-price ratio; VAR model; OECD countries;

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  1. Engsted, Tom & Pedersen, Thomas Q. & Tanggaard, Carsten, 2012. "The Log-Linear Return Approximation, Bubbles, and Predictability," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(03), pages 643-665, June.
  2. Hardouvelis, Gikas A., 1994. "The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 255-283, April.
  3. Stambaugh, Robert F., 1999. "Predictive regressions," Journal of Financial Economics, Elsevier, vol. 54(3), pages 375-421, December.
  4. Campbell, Sean D. & Davis, Morris A. & Gallin, Joshua & Martin, Robert F., 2009. "What moves housing markets: A variance decomposition of the rent-price ratio," Journal of Urban Economics, Elsevier, vol. 66(2), pages 90-102, September.
  5. Robert J. Shiller & John Y. Campbell, 1986. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Cowles Foundation Discussion Papers 812, Cowles Foundation for Research in Economics, Yale University.
  6. Charles Himmelberg & Christopher Mayer & Todd Sinai, 2005. "Assessing High House Prices: Bubbles, Fundamentals, and Misperceptions," NBER Working Papers 11643, National Bureau of Economic Research, Inc.
  7. John H. Cochrane, 2008. "The Dog That Did Not Bark: A Defense of Return Predictability," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1533-1575, July.
  8. Alberto Plazzi & Walter Torous & Rossen Valkanov, 2010. "Expected Returns and Expected Growth in Rents of Commercial Real Estate," Review of Financial Studies, Society for Financial Studies, vol. 23(9), pages 3469-3519.
  9. Engsted, Tom & Pedersen, Thomas Q., 2010. "The dividend-price ratio does predict dividend growth: International evidence," Journal of Empirical Finance, Elsevier, vol. 17(4), pages 585-605, September.
  10. Joshua Gallin, 2008. "The Long-Run Relationship Between House Prices and Rents," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 36(4), pages 635-658, December.
  11. Nathalie Girouard & Mike Kennedy & Paul van den Noord & Christophe André, 2006. "Recent House Price Developments: The Role of Fundamentals," OECD Economics Department Working Papers 475, OECD Publishing.
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Cited by:
  1. John C. Williams, 2013. "Bubbles tomorrow and bubbles yesterday, but never bubbles today?," Speech 122, Federal Reserve Bank of San Francisco.
  2. Tom Engsted & Thomas Q. Pedersen, 2013. "Housing market volatility in the OECD area: Evidence from VAR based return decompositions," CREATES Research Papers 2013-04, School of Economics and Management, University of Aarhus.

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