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Money illusion and housing frenzies

Brunnermeier, Markus K. and Julliard, Christian (2008) Money illusion and housing frenzies. Review of Financial Studies, 21 (1). pp. 135-180. ISSN 1465-7368

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Identification Number: 10.1093/rfs/hhm043

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.

Item Type: Article
Official URL: http://rfs.oxfordjournals.org
Additional Information: © 2007 the author
Subjects: H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Departments > Economics
Date Deposited: 09 May 2008 14:40
Last Modified: 08 Feb 2011 11:45
URI: http://eprints.lse.ac.uk/id/eprint/4801

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