Abstract: I show that when house prices are high relative to rents (that is, when
the rentprice ratio is low) changes in real rents tend to be larger than
usual and changes in real prices tend to be smaller than usual. Standard
errorcorrection models provide inconclusive results about the predictive
power of the rentprice ratio at a quarterly frequency. I use a longhorizon
regression approach to show that the rentprice ratio helps predict changes
in real rents and real prices over threeyear periods. This result withstands
the inclusion of a measure of the user cost of capital. I show that a long
horizon regression approach can yield biased estimates of the degree of
error correction if prices have a unit root but do not follow a random walk.
I construct bootstrap distributions to conduct appropriate inference in the
presence of this bias. The results lend empirical support to the view that
the rentprice ratio is an indicator of valuation in the housing market.
Keywords: House prices, rent, error correction
Full paper (317 KB PDF)
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Last update: October 4, 2004
