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http://www.princeton.edu/~markus/res...g_frenzies.pdf
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 that inflation lowers future real mortgage costs. We decompose the
price-rent ratio in 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.
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 that inflation lowers future real mortgage costs. We decompose the
price-rent ratio in 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.