We construct a modified present value model to investigate the role of fundamentals and speculation in the Korean housing market since the late 80s.
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We append the standard present value model with a speculative bubble which gestate and collapse periodically.
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The fundamental part of the price-rent ratio turns out to be mostly driven by the expected future risk premium for housing investment, not by the expected flow of rent income or the risk-free rate of return.
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Having increased steadily since the early 2000s, the bubble part takes as large as 51% of the actual house price as of 2014:Q3.
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The recent increases in house price over 2007-2014 are likely to have been driven by self-fulfilling expectations typical of a bubble.
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