Empirical Application of the Housing Market No-Arbitrage Condition: Problems, Solutions and a Finnish Case Study

Aboa Centre for Economics Discussion Paper No. 39

30 Pages Posted: 11 Oct 2008 Last revised: 15 Oct 2008

See all articles by Elias Oikarinen

Elias Oikarinen

University of Oulu - Oulu Business School; University of Turku, Department of Economics

Date Written: October 8, 2008

Abstract

The often used housing price-to-income and housing price-to-rent ratios are problematic in housing market analysis and may result in misleading conclusions. Instead, the no-arbitrage condition of housing market is a theoretically sound basis to evaluate if housing prices are misaligned. Unfortunately, empirical application of the no-arbitrage condition has notable complications. This article reviews these complications and suggests some solutions to them. The use of implied expected appreciation derived from the no-arbitrage condition is recommended. It is also claimed that the real appreciation is better to use than the nominal one in the no-arbitrage computations. Furthermore, the paper shows that the maintenance costs as a fraction of housing price vary substantially in time and location, which may significantly affect the equilibrium housing price level relative to rental prices. An empirical application of the no-arbitrage relation using data from ten Finnish cities shows that housing price level in 2007 was not based on high expected appreciation. This lowers the fears for a price bubble.

Keywords: Housing, no-arbitrage condition, overpricing, user cost

JEL Classification: R21

Suggested Citation

Oikarinen, Elias, Empirical Application of the Housing Market No-Arbitrage Condition: Problems, Solutions and a Finnish Case Study (October 8, 2008). Aboa Centre for Economics Discussion Paper No. 39, Available at SSRN: https://ssrn.com/abstract=1280827 or http://dx.doi.org/10.2139/ssrn.1280827

Elias Oikarinen (Contact Author)

University of Oulu - Oulu Business School ( email )

Finland

University of Turku, Department of Economics ( email )

Turku, FIN-20500
Finland

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