Does the Interest Risk Premium Predict Housing Prices?

In this paper we examine the predictability power of long term risk premium over Housing prices in U.S.A. of a period of 19 years (1991-2009). For reasons that are cited clearly in the text, the interest rate risk premium is preferred over yield curve. Under a probit framework, it is tested whether recent housing pricing bust could have been predicted. We employ adaptive expectations for the formation of the agents’ short-term interest rate expectations. The ability to forecast such price changes is of great importance to investors and analysts of the housing market and for the design of financial institutions’ mortgage policy in a more prudential path.Housing prices; risk premium; probit; forecasting