Dynamics of U.S. House Prices : A VECM Approach
Abstract: This paper aims to analyze the U.S. house price dynamics to estimate a long-term equilibrium price level for the U.S. housing market, using fundamental underlying macroeconomic factors. For this, in line with the empirical literature, a vector error-correction model is employed. The results find a cointegrating relationship between the housing prices and its long-run driving factors: Residential Investment Ratio (RIR), Personal Disposable Income (PDI), and Construction Cost (CC), implying that these factors have a decisive role in determining equilibrium level of U.S. house prices. The estimated long-run equilibrium level suggests that the U.S. housing market is currently underpriced, which can bring some skepticism to our model. However, our model does manage to predict future house prices about one year in advance of the actual house price movement. Further, the slow rate of adjustment towards equilibrium testifies of a rigid housing market in the U.S.
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