Friday, February 7, 2014

13 February 2014: What Moves the Price-Rent Ratio? A Modifed Present-Value Approach

Kundan Kishor
University of Wisconsin-Milwaukee, USA

This paper proposes a modified present-value model that takes into account the fact that movements in the price-rent ratio may not be mean-reverting. Our approach decomposes the price-rent ratio into expected real rent growth, expected housing return and a non-present-value (NPV) component that represents the deviation of the price-rent ratio from its conventional present-value level for the 18 U.S. metropolitan areas and the nation from 1975 through 2012. This NPV component takes into account non-stationarity of the price-rent ratio. To estimate this modified present-value model, we use the unobserved component approach. Our findings suggest that the NPV component is significant and sometimes very large both at the national and the regional level. This is especially true for the MSAs that have experienced frequent booms and busts in the housing market. We also find that the MSAs that display larger deviation from the present-value model are more sensitive to mortgage rate changes. Our approach also allows us to estimate the correlation between expected rent growth, expected housing return and the NPV component. We find that the shock to expected housing return and shock to non-stationary NPV component is highly positively correlated in the pre-2006 sample period implying that they did feed off each other. This correlation declined significantly in the post-2006 sample period. Our results also show that most of the variations in the present-value component of the price-rent ratio arise due to the variations in expected housing return.

Date: February 13, 2014
Time: 03:00 P.M.

Seminar Room (First Floor)
Department of Economics,
Delhi School of Economics,
New Delhi-110007(INDIA)


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