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Money illusion and housing frenzies

Brunnermeier, Markus K. and Julliard, Christian (2006) Money illusion and housing frenzies. 579. Financial Markets Group, London School of Economics and Political Science, London, UK.

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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 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.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2006 the authors
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Journal of Economic Literature Classification System: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
R - Urban, Rural, and Regional Economics > R2 - Household Analysis
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Departments > Economics
Collections > LSE Financial Markets Group (FMG) Working Papers
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 579
Date Deposited: 09 May 2008 15:35
URL: http://eprints.lse.ac.uk/4806/

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