Money Illusion and Housing Frenzies

Markus Brunnermeier and Christian Julliard

FMG Discussion Papers from Financial Markets Group

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 FinanceJEL classification: G12, R2.

Date: 2006-07
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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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