Modeling housing prices using a present value state space model

This paper introduces a State Space approach to explain the dynamics
of rent growth, expected returns and Price-Rent ratio in housing markets.
According to the present value model, movements in price to rent ratio
should be matched by movements in expected returns and expected rent
growth. The state space framework assume that both variables follow
an autoregressive process of order one. The model is applied to the US
and UK housing market, which yields series of the latent variables given
the behaviour of the Price-Rent ratio. Resampling techniques and boot-
strapped likelihood ratios show that expected returns tend to be highly
persistent compared to rent growth. The Öltered expected returns is con-
sidered in a simple predictability of excess returns model with high sta-
tistical predictability evidenced for the UK. Overall, it is found that the
present value model tends to have strong statistical predictability in the
UK housing markets.