TITLE:
The Present Value Model Revisited: An Application to the Italian Price-Rent Ratio
AUTHORS:
Jan R. Kim, Gieyoung Lim
KEYWORDS:
Italian Price-Rent Ratio, Bubble Regimes, Regime-Switching Expectation
JOURNAL NAME:
Modern Economy,
Vol.6 No.6,
June
26,
2015
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.