The Long-Run Relationship Between House Prices and Rents

I use standard error-correction models and long-horizon regression models to examine how well the rent-price ratio predicts future changes in real rents and prices. I find evidence that the rent-price ratio helps predict changes in real prices over 4-year periods, but that the rent-price ratio has little predictive power for changes in real rents over the same period. I show that a long-horizon regression approach can yield biased estimates of the degree of error correction if prices have a unit root but do not follow a random walk, and I construct bootstrap distributions to conduct appropriate inference in the presence of this bias. The results lend empirical support to the view that the rent-price ratio is an indicator of valuation in the housing market.