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Empirical application of the housing-market no-arbitrage condition: problems, solutions and a Finnish case study

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  • Elias Oikarinen

    ()
    (Department of Economics, Turku School of Economics)

Abstract

The often used housing price-to-income and housing price-to-rent ratios are problematic in housing market analysis and may result in misleading conclusions. Instead, the no-arbitrage condition of housing market is a theoretically sound basis to evaluate if housing prices are misaligned. Unfortunately, empirical applica-tion of the no-arbitrage condition has notable complications. This article reviews these complications and suggests some solutions to them. The use of implied expected appreciation derived from the no-arbitrage condition is recommended. It is also claimed that the real appreciation is better to use than the nominal one in the no-arbitrage computations. Furthermore, the paper shows that the maintenance costs as a fraction of housing price vary substantially in time and location, which may significantly affect the equilibrium housing price level relative to rental prices. An empirical application of the no-arbitrage relation using data from ten Finnish cities shows that housing price level in 2007 was not based on high expected appreciation. This lowers the fears for a price bubble.

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Bibliographic Info

Paper provided by Aboa Centre for Economics in its series Discussion Papers with number 39.

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Length: 30
Date of creation: Oct 2008
Date of revision:
Handle: RePEc:tkk:dpaper:dp39

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Keywords: Housing; no-arbitrage condition; overpricing; user cost;

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  1. 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.
  2. Sven Rady, 2001. "Housing Market Dynamics: on the Contribution of Income Shocks and Credit Constraints," FMG Discussion Papers dp375, Financial Markets Group.
  3. Edward L. Glaeser & Joseph Gyourko, 2007. "Arbitrage in Housing Markets," NBER Working Papers 13704, National Bureau of Economic Research, Inc.
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  8. Linneman, Peter, 1985. "An economic analysis of the homeownership decision," Journal of Urban Economics, Elsevier, vol. 17(2), pages 230-246, March.
  9. Jonathan Heathcote & Morris Davis, 2004. "The Price and Quantity of Residential Land in the United States," 2004 Meeting Papers 32, Society for Economic Dynamics.
  10. Andrea Finicelli, 2007. "House price developments and fundamentals in the United States," Questioni di Economia e Finanza (Occasional Papers) 7, Bank of Italy, Economic Research and International Relations Area.
  11. Englund, P. & Hendershott, P.H. & Turner, B., 1995. "The Tax Reform and the Housing Market," Papers 20, Uppsala - Working Paper Series.
  12. 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.
  13. James M. Poterba, 1983. "Tax Subsidies to Owner-occupied Housing: An Asset Market Approach," Working papers 339, Massachusetts Institute of Technology (MIT), Department of Economics.
  14. John M. Quigley & Steven Raphael, 2004. "Is Housing Unaffordable? Why Isn't It More Affordable?," Journal of Economic Perspectives, American Economic Association, vol. 18(1), pages 191-214, Winter.
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