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Money Illusion and Housing Frenzies

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Author Info
Markus K. Brunnermeier
Christian Julliard

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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 nominalinterest 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. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhm043
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Publisher Info
Article provided by Oxford University Press for Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 21 (2008)
Issue (Month): 1 (January)
Pages: 135-180
Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Handle: RePEc:oup:rfinst:v:21:y:2008:i:1:p:135-180

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  1. Andrea Finicelli, 2007. "House price developments and fundamentals in the United States," Questioni di Economia e Finanza (Occasional Papers) 7, Bank of Italy, Economic Research Department. [Downloadable!]
  2. Maik Schmeling & Andreas Schrimpf, 2008. "Expected Inflation, Expected Stock Returns, and Money Illusion: What can we learn from Survey Expectations?," SFB 649 Discussion Papers SFB649DP2008-036, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
  3. Matteo Iacoviello & Stefano Neri, 2007. "Housing Market Spillovers: Evidence from an Estimated DSGE Model," Boston College Working Papers in Economics 659, Boston College Department of Economics, revised 22 Jan 2008. [Downloadable!]
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  4. Carl Chen & Peter Lung & F. Wang, 2009. "Mispricing and the cross-section of stock returns," Review of Quantitative Finance and Accounting, Springer, vol. 32(4), pages 317-349, May. [Downloadable!] (restricted)
  5. Ralph S.J Koijen & Otto Van Hemert & Stijn Van Nieuwerburgh, 2007. "Mortgage Timing," NBER Working Papers 13361, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Robert J Shiller, 2007. "Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Models," Levine's Bibliography 122247000000001682, UCLA Department of Economics. [Downloadable!]
  7. Robert J. Shiller, 2007. "Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Models," Cowles Foundation Discussion Papers 1632, Cowles Foundation, Yale University. [Downloadable!]
  8. Robert J. Shiller, 2007. "Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Economic Models," NBER Working Papers 13558, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Monika Piazzesi & Martin Schneider, 2007. "Inflation Illusion, Credit, and Asset Pricing," NBER Working Papers 12957, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Eerola, Essi & Määttänen, Niku, 2008. "On the importance of borrowing constraints for house price dynamics," Research Discussion Papers 8/2008, Bank of Finland. [Downloadable!]
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