What drives returns to euro area housing? Evidence from a dynamic dividend-discount model

We apply a dynamic dividend-discount model to analyse unexpected housing returns in a panel of eight euro area countries which together comprise 90% of euro area GDP. The application of this model allows for a decomposition of house price movements into movements in rent (cash-flow) and expected ret...

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Bibliographic Details
Published in:Policy File 2009
Main Authors: Hiebert, Paul, Sydow, Matthias
Format: Report
Language:English
Subjects:
Banking/Finance
Economic policy
European Central Bank
Housing
Online Access:Request full text
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Summary:We apply a dynamic dividend-discount model to analyse unexpected housing returns in a panel of eight euro area countries which together comprise 90% of euro area GDP. The application of this model allows for a decomposition of house price movements into movements in rent (cash-flow) and expected return news components. The empirical application of the model involves the estimation of a panel vector autoregressive model (VAR) for four variables -excess return to housing, rents, the real interest rate and real disposable per capita income- using quarterly data over the period 1985-2007. This empirical investigation yields two main findings. First, the bulk of the variability of house price movements in the panel of countries analyzed can be attributed to movements in the rental yield. Indeed, perturbations to rents appear to result in a one-to-one analogous movement in house prices over the long term once controlling for changes in expected returns. Second, evidence from the dynamic profile of shocks along with the negative co-movement between changing rental yield expectations and changing expected returns on housing assets would suggest that euro area house prices overreact to news.