The Present Value Model Revisited: An Application to the Italian Price-Rent Ratio

Jan R. Kim, Gieyoung Lim^*

Department of International Economics and Law, Hankuk University of Foreign Studies, Seoul, Republic of Korea.

DOI: 10.4236/me.2015.66069                

Abstract

The present value model of asset prices a la Campbell and Shiller predicts the price-rent ratio in the housing market to be stationary. The observed movements in the actual price-rent ratio, often exhibiting large and long swings in the ratio, may put into question the validity of the standard present value model. In this paper, we allow for two sources of possibly unwieldy deviations in the price-rent ratio in the standard present value model, and examine the relative importance of the standard model and the two extra features using the Italian house market data. The results strongly support the validity of the standard present value model, in which the up- and down-swings in the price-rent ratio are mostly explained by the movement in the expected risk premium, whereas the bubble and regime-switching expectation does not make sizable contributions to the price-rent ratio. Our results suggest that the standard present value model is a reliable vehicle in explaining the price-rent ratio.

Keywords

Italian Price-Rent Ratio, Bubble Regimes, Regime-Switching Expectation

Conflicts of Interest

The authors declare no conflicts of interest.

References

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