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A trend and variance decomposition of the rent-price ratio in housing markets

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Author Info

  • Sean D. Campbell
  • Morris A. Davis
  • Joshua Gallin
  • Robert F. Martin

Abstract

We use the dynamic Gordon-growth model to decompose the rent-price ratio for owner-occupied housing in the U.S., four Census regions, and twenty-three metropolitan areas into three components: The expected present value of real rental growth, real interest rates, and future housing premia. We use these components to decompose the trend and variance in rent-price ratios for 1975-2005, for an early sub-sample (1975-1996), and for the recent housing boom (1997-2005). We have three main findings. First, variation in expected future real rents accounts for a small share of variation in our sample rent-price ratios; variation in real interest rates and housing premia account for most of the variability. Second, expected future real rates and housing premia were so strongly negatively correlated prior to 1997 that changes to real interest rates did not affect the rent-price ratio. After 1997, rates and premia have been positively correlated, and the decline in the rent-price ratio that has occurred in almost every geographic area in our sample since 1997 reflects both declining real rates and declining premia. Third, we show that in the recent housing boom, 65 percent of the decline in the aggregate rent-price ratio is due to a declining housing premium.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2006-29.

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Date of creation: 2006
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Handle: RePEc:fip:fedgfe:2006-29

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Related research

Keywords: Housing - Finance ; Housing - Prices ; Rental housing;

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References

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  1. Jonathan McCarthy & Richard W. Peach, 2004. "Are home prices the next "bubble"?," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 1-17.
  2. Karl E. Case & Robert J. Shiller, 2003. "Is There a Bubble in the Housing Market?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(2), pages 299-362.
  3. Robert J. Shiller & Andrea E. Beltratti, 1990. "Stock Prices and Bond Yields: Can Their Comovements Be Explained in Terms of Present Value Models?," NBER Working Papers 3464, National Bureau of Economic Research, Inc.
  4. Steven A. Sharpe, 2002. "Reexamining Stock Valuation and Inflation: The Implications Of Analysts' Earnings Forecasts," The Review of Economics and Statistics, MIT Press, vol. 84(4), pages 632-648, November.
  5. Case, Karl E & Shiller, Robert J, 1989. "The Efficiency of the Market for Single-Family Homes," American Economic Review, American Economic Association, vol. 79(1), pages 125-37, March.
  6. Joshua Gallin, 2004. "The long-run relationship between house prices and rents," Finance and Economics Discussion Series 2004-50, Board of Governors of the Federal Reserve System (U.S.).
  7. Campbell, John Y & Shiller, Robert J, 1988. " Stock Prices, Earnings, and Expected Dividends," Journal of Finance, American Finance Association, vol. 43(3), pages 661-76, July.
  8. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
  9. Meese Richard & Wallace Nancy, 1994. "Testing the Present Value Relation for Housing Prices: Should I Leave My House in San Francisco?," Journal of Urban Economics, Elsevier, vol. 35(3), pages 245-266, May.
  10. John Y. Campbell & John Ammer, 1991. "What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns," NBER Working Papers 3760, National Bureau of Economic Research, Inc.
  11. 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.
  12. 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.
  13. John Y. Campbell, 1990. "A Variance Decomposition for Stock Returns," NBER Working Papers 3246, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Bolt, W. & Demertzis, D. & Diks, C.G.H. & Van der Leij, M.J., 2011. "Complex Methods in Economics: An Example of Behavioral Heterogeneity in House Prices," CeNDEF Working Papers 11-12, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  2. Frederic S. Mishkin, 2007. ""Housing and the monetary transmission mechanism," Finance and Economics Discussion Series Working Paper: a speech at the Federal Reserve Bank of Kansas City's Economic Symposium, Jackson Ho," Speech 312, Board of Governors of the Federal Reserve System (U.S.).
  3. Andrew Haughwout & Donghoon Lee & Joseph Tracy & Wilbert van der Klaauw, 2011. "Real estate investors, the leverage cycle, and the housing market crisis," Staff Reports 514, Federal Reserve Bank of New York.
  4. McQuinn, Kieran & O'Reilly, Gerard, 2006. "Assessing the Role of Income and Interest Rates in Determining House Prices," Research Technical Papers 15/RT/06, Central Bank of Ireland.
  5. Frederic S. Mishkin, 2007. "Housing and the Monetary Transmission Mechanism," NBER Working Papers 13518, National Bureau of Economic Research, Inc.
  6. McQuinn, Kieran & O' Reilly, Gerard, 2007. "A Model of Cross-Country House Prices (228.91 KB PDF)," Research Technical Papers 5/RT/07, Central Bank of Ireland.
  7. Vyacheslav Mikhed & Petr Zemcik, 2007. "Testing for Bubbles in Housing Markets: A Panel Data Approach," CERGE-EI Working Papers wp338, The Center for Economic Research and Graduate Education - Economic Institute, Prague.

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