Journal Article Presentation:
Shocks and Valuation in the Rental Housing Market
Alm, James and Follain, James “Shocks and Valuation in the Rental Housing Market,” Journal of Urban Economics, 36 (September 1994): 117-142. Presented by Cynthia S. Blasses November 25, 2002
Introduction and Objectives
• Theoretical paper exploring impact of major shocks in the rental housing market • Develops a structural dynamic model of simultaneous equations
– – – – demand supply construction asset price
A Perfect Foresight Model
• Formulation of expectations • Equations link price with future expected rents • Manipulating the equations– Future values are eliminated using only current & lagged values of rent & price
• Pt represents the present value of actual future path of rents
Model Equations
Rt = a0 + a1Kt + a2Yt
Kt = (1-d)Kt-1+ Ct Ct = α(Pt - P*)
r Pt (1 r ) Pt 1 Rt d r
(Demand)
(Supply) (Construction) (Price)
Parameters a0 , a2 > 0 , Parameter a1 < 0
The Solution
• To solve this system of linear simultaneous difference equations, Alm and Follain develop a second-order difference equation
E = Rt + D1Rt-1 + D2Rt-2
Where it is assumed that Yt = Yt-1 = Yt-2 = YT
E t t Rt F1 (b1 ) F2 (b2 ) (1 D1 D2 )
• Where the particular solution represents a steady state value for rent • And the characteristic roots (b1, b2) determine the dynamic behavior of rent over time.
Adjustment Paths
• The adjustment path of rent depends on b1 & b2 • The path oscillates over time
D1>0, D2<0
• Convergence to steady-state requires b1 & b2 to be less than one in absolute value • Speed of adjustment is affected by many factors
– in general, the smaller the characteristic roots, the faster the market converges to equilibrium
Concluding Recommendations
• Additional structure
– Demand & construction equations derived from intertemporal utility and profit maximization
• Alternative expectations models should be explored
– Specifically, a Rational Expectations Model
• Actual estimation of one or more of the equations presented
– Econometric estimations of model parameters