Abstract
In this paper, we investigate the macroeconomic drivers of house prices in Israel, the OECD country with the highest growth rate in recent years, and test for the divergence of observed prices from underlying fundamentals using cointegration analysis and error correction models for the 1998 to 2013 period. While the recent surge in house prices is partially explained by fundamentals such as population growth, low unemployment, and interest rates along with supply constraints, the results suggest that prices have deviated from fundamental values by approximately 20% from 2009 onwards. Stock market volatility is found to be 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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