Money Illusion and Housing Frenzies

48 Pages Posted: 5 Jan 2007 Last revised: 18 May 2015

See all articles by Christian Julliard

Christian Julliard

London School of Economics & Political Science (LSE) - Department of Finance; Centre for Economic Policy Research (CEPR)

Markus K. Brunnermeier

Princeton University - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: December 2006

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 unlikely to rationalize this finding.

Suggested Citation

Julliard, Christian and Brunnermeier, Markus Konrad, Money Illusion and Housing Frenzies (December 2006). NBER Working Paper No. w12810, Available at SSRN: https://ssrn.com/abstract=955243

Christian Julliard

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Markus Konrad Brunnermeier (Contact Author)

Princeton University - Department of Economics ( email )

Bendheim Center for Finance
Princeton, NJ
United States
609-258-4050 (Phone)
609-258-0771 (Fax)

HOME PAGE: http://www.princeton.edu/¡­markus

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