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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. Jonathan Heathcote & Morris Davis, 2004. "The Price and Quantity of Residential Land in the United States," 2004 Meeting Papers 32, Society for Economic Dynamics.
  2. Ortalo-Magné, François & Rady, Sven, 2001. "Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraints," CEPR Discussion Papers 3015, C.E.P.R. Discussion Papers.
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  10. DiPasquale Denise & Wheaton William C., 1994. "Housing Market Dynamics and the Future of Housing Prices," Journal of Urban Economics, Elsevier, vol. 35(1), pages 1-27, January.
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