Abstract
A number of countries have experienced remarkably high growth rates in house prices since the Global Financial Crisis. This paper investigates the macroeconomic drivers of house prices in Israel, the OECD country with the highest growth rate, and tests for divergence of observed prices from underlying fundamentals. Applying cointegration and error-correction models to a comprehensive dataset of macroeconomic and financial data from 1998 to 2013, we model both the long-run equilibrium relationship and the short-run dynamics. While the surge in house prices is partially explained by fundamentals such as population growth, low unemployment and interest rates along with supply constraints, our results suggest that over the last four years of the study period, prices have deviated from fundamental values by approximately 20 percent. We also show that stock market volatility is a key predictor of house prices in the short run, indicating a shift towards increased investment in the housing market when other asset classes, notably the stock market, are perceived as very risky.
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