Abstract
A reduction in inflation can fuel run-ups in housing prices if people suffer from money illusion. For example, investors who decide whether to rent or buy a house by simply comparing monthly rent and mortgage payments do not take into account the fact that inflation lowers future real mortgage costs. We decompose the price-rent ratio into a rational component-meant to capture the "proxy effect" and risk premia- and an implied mispricing. We find that inflation and nominal interest rates explain a large share of the time series variation of the mispricing, and that the tilt effect is very unlikely to rationalize this finding.
Original language | English (US) |
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Pages (from-to) | 135-180 |
Number of pages | 46 |
Journal | Review of Financial Studies |
Volume | 21 |
Issue number | 1 |
DOIs | |
State | Published - Jan 2008 |
All Science Journal Classification (ASJC) codes
- Accounting
- Finance
- Economics and Econometrics