House Prices, Expectations, and Time-Varying Fundamentals

Abstract

We investigate the behavior of the equilibrium price-rent ratio for housing in a standard asset pricing model. We allow for time-varying risk aversion (via external habit formation) and time-varying persistence and volatility in the stochastic process for rent growth, consistent with U.S. data for the period 1960 to 2011. Under fully-rational expectations, the model significantly underpredicts the volatility of the U.S. price-rent ratio for reasonable levels of risk aversion. We demonstrate that the model can approximately match the volatility of the price-rent ratio in the data if near-rational agents continually update their estimates for the mean, persistence and volatility of fundamental rent growth using only recent data (i.e., the past 4 years), or if agents employ a simple moving-average forecast rule for the price-rent ratio that places a large weight on the most recent observation. These two versions of the model can be distinguished by their predictions for the correlation between expected future returns on housing and the price-rent ratio. Only the moving-average model predicts a positive correlation such that agents tend to expect higher future returns when house prices are high relative to fundamentals-a feature that is consistent with survey evidence on the expectations of real-world housing investors.

Macroprudential Policy Tools in Norway

“…The results are modified significantly if the actual house price inflation rates in the past years are used for the expected capital gain term, assuming that expectations on house prices are formed in an extrapolative way. Gelain and Lansing (2013) show that expectations of extrapolative nature can better explain many features in Norwegian data such as the positive correlation between the current price-to-rent ratios and future realised returns compared with rational expectation models.…”

“…Jurgilas and Lansing (2012) for example found a positive correlation between the current price-to-rent ratios and future realised returns in Norwegian data. Gelain and Lansing (2013) show that this situation is better explained when expectations are modified so that they are simply of extrapolative nature (i.e. moving-average) compared with the baseline case where expectations are rational (even when the latter takes into account such factors as changes in risk-aversion) within a framework of the capital asset pricing model.…”

Emotions, Uncertainty, Gender and Residential Real Estate Prices: Evidence from a Bubble Market

“…In a recent study of 36 countries (including Ireland) Aizenman and Jinjarak (20143) find that past price changes are the most important factor determining subsequent real estate price appreciation, concluding that the concerns of regarding irrational exuberance apply globally. Gelain and Lansing (2014) find that fully rational expectations models significantly under-predict the volatility of the US price-to-rent ratio for 1 Ikramov and Yavas (2012) find in experimental real estate markets such limits to arbitrage impact on the magnitude of bubbles.…”

Interactions between real economic and financial sides of the US economy in a regime-switching environment

“…One strand of the literature emphasizes that asset prices influence current expenditure solely to the extent that they are 'leading indicators' of the future variations in economic activity. Additionally, forward-looking, rational economic agents incorporate the fluctuations in financial asset prices in their expectations (Gelain and Lansing, 2013), which in turn affects the propagation mechanism of shocks. The emergence of asset-price inflations caused a reappraisal of what monetary policy makers should or should not do when faced with rapid increases in asset prices.…”