Implications of intertemporal optimization for house and land prices

Abstract

The Euler equation is used for the intertemporal allocation of durable goods in conjunction with a simple model of housing flow supply to derive implications for the relation between house and land prices. Data from England and Wales fails a key time series test in this respect. The rejection of the theory is shown to be mainly due to the specification of the housebuilding industry: perfect competition makes house prices cointegrated with land prices and housebuilding costs. There is also evidence that borrowing constraints impair the validity of the representative-agent framework for the housing sector.