Ruhr Economic Papers

Ruhr Economic Papers #620

House Prices and Interest Rates – Bayesian Evidence from Germany

by Christoph Hanck and Jan Prüser

RGS, UDE, 06/2016, 42 S./p., 8 Euro, ISBN 978-3-86788-722-9 DOI: 10.4419/86788722

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Abstract

This study uses a Bayesian VAR to demonstrate that the recent house price boom in
Germany can be explained by falling interest rates and that higher interest rates are likely
suciffi ent to stop the increase of German house prices. The latter suggests a potential
drawback of the current monetary policy of the ECB. The BVAR’s prior information
shrinks the model parameters towards a parsimonious benchmark. We provide a
simulation study to compare the frequentist properties of two useful strategies to select
the informativeness of the prior. The study reveals that prior information helps to obtain
more precise estimates of impulse response functions in small samples. To choose
relevant control variables, we use a new Bayesian variable selection approach by Ding
and Karlsson (2014). In addition to impulse responses and variance decompositions,
we use a Bayesian conditional forecast to test the hypothetical eff ect of an increase
of interest rates on house prices. This approach has the crucial advantage that it is
invariant to the ordering of the variables.

JEL-Classification: C11, C32, C53, E37,

Keywords: Bayesian VAR; shrinkage; house prices

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