Expectations, Efficiency, and Euphoria in the Housing Market

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This paper studies expectations of capital appreciation in the housing market. We show that expectations impounded in the rent/price ratio at the beginning of the decade successfully predict appreciation rates, but only if we first control for cross-sectional differences in the quality of rental versus owner-occupied housing. We also demonstrate that observed rent/price ratios contain a disequilibrium component that also has power to forecast subsequent appreciation rates. Finally, we provide evidence consistent with euphoria: participants in housing markets appear to overreact to income growth.

Published: Regional Science & Urban Economics, vol. 26, no. 3-4, pp. 369-386, June 1996

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