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Long Run Expectations, Learning and the U.S. Housing Market

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  • Daniel Tortorice

    () (Brandeis University)

Abstract

This paper examines key facts about the U.S. housing market. The price to rent ratio is highly volatile and significantly autocorrelated. Returns on housing are positively autocorrelated. The price to rent ratio is negatively correlated with future returns on housing and future rent growth. Finally, housing returns exhibit significant time varying volatility. I show that a benchmark rational expectations general equilibrium asset pricing model is inconsistent with these facts. I modify the model in two ways to improve its fit with the data. First, I allow for pricing frictions so prices adjust slowly to their fundamental value. Second, I assume the agent does not know if housing fundamentals, captured by rental flows, are stationary or non-stationary and has changing beliefs depending on how well each model fits the current data. I find that these modifications allow the model to increase the volatility of the price to rent ratio and to match the autocorrelation of housing returns. The price to rent ratio then negatively forecasts returns and rent growth. Finally the model generates time varying volatility consistent with the data.

Suggested Citation

  • Daniel Tortorice, 2015. "Long Run Expectations, Learning and the U.S. Housing Market," Working Papers 85, Brandeis University, Department of Economics and International Businesss School.
  • Handle: RePEc:brd:wpaper:85
    as

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    File URL: http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP85.pdf
    File Function: First version, 2015
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    References listed on IDEAS

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    Cited by:

    1. repec:eee:jeborg:v:148:y:2018:i:c:p:315-343 is not listed on IDEAS
    2. Tortorice, Daniel L., 2018. "Equity return predictability, time varying volatility and learning about the permanence of shocks," Journal of Economic Behavior & Organization, Elsevier, vol. 148(C), pages 315-343.

    More about this item

    Keywords

    Learning; Expectations; Housing Demand; Asset Pricing;

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics

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