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Depreciation: a Dangerous Affair

Cozzi, Guido (2017): Depreciation: a Dangerous Affair.

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Statutory fiscal depreciation of real estates is typically higher than their realistic expected life. This would imply that markets would value buildings more than their social fundamental value. I prove that this allows house price bubbles to emerge and open the door to sudden crashes, even in an economy with fully rational and forward-looking individuals, and no credit market imperfections. I also provide a simple "rule-of-thumb" method to calculate the highest bubble-free depreciation rate. With standard parameters, it turns out that the usual annual 5% fiscal depreciation can prevent house price bubbles only by a very close shave.

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