CES - Discussion paper series, DPS14.09 pages:1-49
We propose that the borrower’s ability to pay through a mortgage is a long-run house price fundamental and …find convincing evidence by means of cointegration tests, granger causality, and an elasticity of house prices with respect to ability to pay close to one. Ability to pay incorporates the effect of a decreasing trend in interest rates, changes in mortgage interest deduction and the recent innovation in mortgage products. We apply the model to the United States of America, United Kingdom, Belgium, the Netherlands, Sweden, Norway, Finland and Denmark. The results provide an intuitive alternative to standard house price models.