Money illusion and housing frenzies

Markus Brunnermeier and Christian Julliard

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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: housing; real estate; inflation; inflation Illusion; mortgages; behavioral finance (search for similar items in EconPapers)
JEL-codes: G12 R2 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2006-07-24
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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http://eprints.lse.ac.uk/4806/ Open access version. (application/pdf)

Related works:
Journal Article: Money Illusion and Housing Frenzies (2008)
Working Paper: Money Illusion and Housing Frenzies (2007)
Working Paper: Money Illusion and Housing Frenzies (2006)
Working Paper: Money Illusion and Housing Frenzies (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:4806

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