Money Illusion and Housing Frenzies

Markus Brunnermeier and Christian Julliard

No 6183, CEPR Discussion Papers from Centre for Economic Policy Research

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.

Keywords: Behavioural finance; Housing; Inflation illusion; Interest rate; Mortgages; Money illusion; Real estate (search for similar items in EconPapers)
JEL-codes: G12 R2 (search for similar items in EconPapers)
Date: 2007-03
New Economics Papers: this item is included in nep-geo, nep-mac, nep-mon and nep-ure
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Citations: View citations in EconPapers (22)

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Related works:
Journal Article: Money Illusion and Housing Frenzies (2008)
Working Paper: Money illusion and housing frenzies (2006)
Working Paper: Money Illusion and Housing Frenzies (2006)
Working Paper: Money Illusion and Housing Frenzies (2006)
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