Regime-Dependent Housing Valuations: Price-Rent Ratios, Volatility, and Structural Breaks in U.S. Markets

Kishor, N. Kundan (2025): Regime-Dependent Housing Valuations: Price-Rent Ratios, Volatility, and Structural Breaks in U.S. Markets.

Abstract

We propose a present value model with structural breaks to explain why U.S. house prices remain persistently high relative to rents—a pattern that standard time-invariant models struggle to capture. Our model uses quarterly data from 1975 to 2023 and incorporates the time-varying volatility of the net discount factor as a key priced risk factor. We find five distinct periods with very different pricing patterns. During the Great Moderation (1981-2001), the usual textbook logic held: higher expected rent growth pushed valuations up, while higher discount rates pulled them down. But in the stagflation era of the late 1970s and again in the recent period (2016-2023), these relationships reversed-higher expected rent growth actually lowered valuations. The two big housing booms of the 2000s and the recent period arose through different forces: the 2000s boom saw prices break free from rents, while the recent period showed an unusually strong reaction to discount rates and a new positive role for volatility, suggesting that uncertainty itself made housing more attractive. These shifting patterns show that what once looked like model failures are better understood as signs of changing market regimes.

• Item Type: MPRA Paper
• Language: English
• Keywords: Present Value Model of Housing, Price-Rent Ratio, Structural Break, Volatility Models.
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; R - Urban, Rural, Regional, Real Estate, and Transportation Economics > R2 - Household Analysis > R21 - Housing Demand

References

\bibitem[Ambrose et al.(2013)]{ambrose2013} Ambrose, B.~W., Eichholtz, P., \& Lindenthal, T. (2013). House prices and fundamentals: 355 years of evidence. \emph{Journal of Money, Credit and Banking}, \textit{45}(2-3), 477-491.

\bibitem[Bai and Perron(2003)]{bai2003} Bai, J. \& Perron, P. (2003). Computation and analysis of multiple structural change models.\emph{Journal of Applied Econometrics}, \textit{18}(1), 1--22.

\bibitem[Barberis et al.(2018)]{barberis2018} Barberis, N., Greenwood, R., Jin, L., \& Shleifer, A. (2018). Extrapolation and bubbles. \emph{Journal of Financial Economics}, \textit{129}(2), 203--227.

\bibitem[Blanchard and Watson(1982)]{blanchard1982} Blanchard, O.~J., \& Watson, M.~W. (1982). Bubbles, rational expectations and financial markets. \emph{NBER Working Paper} No. 945.

\bibitem[Bolt et al.(2019)]{bolt2019} Bolt, W., Demertzis, M., Diks, C., Hommes, C., \& van der Leij, M. (2019). Identifying booms and busts in house prices under heterogeneous expectations. \emph{Journal of Economic Dynamics and Control}, \textit{103}, 234--259.

\bibitem[Bordalo et al.(2020)]{bordalo2020} Bordalo, P., Gennaioli, N., Ma, Y., \& Shleifer, A. (2020). Overreaction in macroeconomic expectations. \emph{American Economic Review}, \textit{110}(9), 2748--2782.

\bibitem[Burnside et al.(2016)]{burnside2016} Burnside, C., Eichenbaum, M., \& Rebelo, S. (2016). Understanding booms and busts in housing markets. \emph{Journal of Political Economy}, \textit{124}(4), 1088--1147.

\bibitem[Campbell and Shiller(1988)]{campbell1988} Campbell, J.~Y., \& Shiller, R.~J. (1988). The dividend–price ratio and expectations of future dividends and discount factors. \emph{The Review of Financial Studies}, \textit{1}(3), 195–228.

\bibitem[Campbell et al.(2009)]{campbell2009} Campbell, S.~D., Davis, M.~A., Gallin, J., \& Martin, R.~F. (2009). What moves housing markets: A variance decomposition of the rent--price ratio. \emph{Journal of Urban Economics}, \textit{66}(2), 90--102.

\bibitem[Case and Shiller(2003)]{case2003} Case, K.~E., \& Shiller, R.~J. (2003). Is there a bubble in the housing market? \emph{Brookings Papers on Economic Activity}, \textit{2003}(2), 299--362.

\bibitem[Case et~al.(2012)]{case2012} Case, K.~E., Shiller, R.~J., \& Thompson, A. (2012). What have they been thinking? Home buyer behavior in hot and cold markets. \emph{NBER Working Paper} No.~18400, National Bureau of Economic Research.

\bibitem[Cochrane(2011)]{cochrane2011} Cochrane, J.~H. (2011). Presidential address: Discount rates. \emph{The Journal of Finance}, \textit{66}(4), 1047-1108.

\bibitem[Davis et~al.(2008)]{davis2008} Davis, M.~A., Lehnert, A., \& Martin, R.~F. (2008). The rent-price ratio for the aggregate stock of owner-occupied housing. \emph{Review of Income and Wealth}, \textit{54}(2), 279-284.

\bibitem[Engsted and Pedersen(2015)]{engsted2015} Engsted, T., \& Pedersen, T.~Q. (2015). Predicting returns and rent growth in the housing market using the rent-price ratio: Evidence from the OECD countries. \emph{Journal of International Money and Finance}, \textit{53}, 257--275.

\bibitem[Fairchild et al.(2015)]{fairchild2015} Fairchild, J., Ma, J., \& Wu, S. (2015). Understanding housing market volatility. \emph{Journal of Money, Credit and Banking}, \textit{47}(7), 1309-1337.

\bibitem[Favilukis et al.(2017)]{favilukis2017} Favilukis, J., Ludvigson, S.~C., \& Van Nieuwerburgh, S. (2017). The macroeconomic effects of housing wealth, housing finance, and limited risk sharing in general equilibrium. \emph{Journal of Political Economy}, \textit{125}(1), 140--223.

\bibitem[Gallin(2008)]{gallin2008}Gallin, J. (2008).The long-run relationship between house prices and rents.\emph{Real Estate Economics}, \textit{36}(4), 635-658.

\bibitem[Gao and Martin(2021)]{gao2021} Gao, P., \& Martin, I.~W. (2021). Volatility, valuation ratios, and bubbles: An empirical measure of market sentiment. \emph{The Journal of Finance}, \textit{76}(6), 3211--3254.

\bibitem[Giglio and Kelly(2018)]{giglio2018} Giglio, S., \& Kelly, B. (2018). Excess volatility: Beyond discount rates. \emph{The Quarterly Journal of Economics}, \textit{133}(1), 71-127.

\bibitem[Glaeser et al.(2008)]{glaeser2008} Glaeser, E.~L., Gyourko, J., \& Saiz, A. (2008). Housing supply and housing bubbles. \emph{Journal of Urban Economics}, \textit{64}(2), 198-217.

\bibitem[Glaeser and Nathanson(2017)]{glaeser2017} Glaeser, E.~L., \& Nathanson, C.~G. (2017). An extrapolative model of house price dynamics. \emph{Journal of Financial Economics}, \textit{126}(1), 147--170.

\bibitem[Greenwald and Guren(2021)]{greenwald2021} Greenwald, D.~L., \& Guren, A.~M. (2021). Do credit conditions move house prices? \emph{NBER Working Paper} No. 29391.

\bibitem[Himmelberg et al.(2005)]{himmelberg2005} Himmelberg, C., Mayer, C., \& Sinai, T. (2005). Assessing high house prices: Bubbles, fundamentals and misperceptions. \emph{Journal of Economic Perspectives}, \textit{19}(4), 67-92.

\bibitem[Jordà et al.(2015)]{jorda2015} Jordà, Ò., Schularick, M., \& Taylor, A.~M. (2015). Betting the house. \emph{Journal of International Economics}, \textit{96}, S2--S18.

\bibitem[Kaplan et al.(2020)]{kaplan2020} Kaplan, G., Mitman, K., \& Violante, G.~L. (2020). The housing boom and bust: Model meets evidence. \emph{Journal of Political Economy}, \textit{128}(9), 3285-3345.

\bibitem[Kim and Chung(2014)]{kimchung2014} Kim, J.~R., \& Chung, K. (2014). Regime switching and the (in)stability of the price–rent relationship: Evidence from the US. \emph{Applied Economics}, \textit{46}(33), 4041–4052

\bibitem[Kishor and Morley(2015)]{kishor2015} Kishor, N.~K., \& Morley, J. (2015). What factors drive the price–rent ratio for the housing market? A modified present‑value analysis. \emph{Journal of Economic Dynamics and Control}, \textit{58}, 235–249.

\bibitem[Lettau and van Nieuwerburgh(2008)]{lettau2008} Lettau, M., \& van Nieuwerburgh, S. (2008). Reconciling the return predictability evidence. \emph{Review of Financial Studies}, \textit{21}(4), 1607–1652.

\bibitem[Luo and Ma(2024)]{luo2024} Luo, S., \& Ma, J. (2024). International housing markets and the US subprime crisis. \emph{Journal of Money, Credit and Banking}, \textit{56}(2-3), 647--669.

\bibitem[Ma et~al.(2007)]{ma2007} Ma, J., Nelson, C.~R., \& Startz, R. (2007). Spurious inference in the GARCH (1, 1) model when it is weakly identified. \emph{Studies in Nonlinear Dynamics \& Econometrics}, \textit{11}(1).

\bibitem[Matteson and James(2014)]{matteson2014nonparametric} Matteson, D. S., \& James, N. A. (2014). A nonparametric approach for multiple change point analysis of multivariate data. \emph{Journal of the American Statistical Association}, \textit{109}(505), 334--345.

\bibitem[Piazzesi and Schneider(2009)]{piazzesi2009} Piazzesi, M., \& Schneider, M. (2009). Momentum traders in the housing market: Survey evidence and a search model. \emph{American Economic Review}, \textit{99}(2), 406--411.