F ADS VERSUS FUNDAMENTALS IN FARMLAND PRICES

We develop an approach to decompose farmland price time series into three uncorrelated com-ponents: permanent fundamental component, temporary fundamental component, and nonfun-damental component. This decomposition is useful for studying the importance of fundamental versus nonfundamental factors in explaining farmland price behavior and the dynamic response of farmland prices to shocks to each of these components. The approach is applied to annual Iowa farmland prices over the 1922-94 sample period. We find that fads and overreactions play important roles in explaining short-run price behavior, while long-run price movements are ex-plainable by permanent fundamental shocks. Key words: bubbles, fads, farmland prices, present value model. A consensus appears to be forming that farm-land price movements are not well explained by the present value model with rational ex-pectations (see, for example, Burt; Feather-stone and Baker; Falk 1991, 1992; and Han-son and Meyers). Although the specific meth-ods and data sets differ across these articles, each one formally or informally rejects the present value model as an explanation of farmland prices. The reasons for the empirical failure of the present value model are not clear. Burt con-cludes that deviations of farmland price from its fundamental path can be explained in terms of overreaction to rent movements. Feather-stone and Baker, on the other hand, conclude that these deviations are largely determined by purely speculative forces, i.e., by fads. No one, however, has attempted to quantify the fad component to help resolve this basic issue. The purpose of this article is to suggest and apply an empirical strategy to decompose farmland price movements into a component driven by fundamental forces and a compo-nent driven by fad forces. This decomposition will provide measures that will help resolve the issue of the relative importance of these two components in explaining overall farm-land price movements. In addition, we wil