Housing, House Prices, and the Equity Premium Puzzle
Morris A. Davis
Rutgers Business School
Robert F. Martin
Federal Reserve Board - International Finance Division
FEDS Working Paper No. 2005-13
Many recent papers have claimed that when housing services are treated separately from other forms of consumption in utility, a wide range of economic puzzles such as the equity premium puzzle can be explained. Our paper challenges these claims. The key assumption embedded in this literature is that households are not very willing to substitute housing services for consumption. We show that housing services and consumption must be much more substitutable than has been assumed for a neoclassical consumption model to be consistent with U.S. house price data. Further, when forced to match both historical house prices and stock returns, the lowest risk-free rate the model can generate is 11 percent.
Number of Pages in PDF File: 20
Keywords: House prices, housing, equity premium
JEL Classification: G12, R21, R31, E01
Date posted: April 15, 2005
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