Journal Article Presentation: Shocks and Valuation in the Rental Housing Market Alm, James and Follain, James “Shocks and Valuation in the Rental Housing Market,” Journal of Urban Economics, 36 (September 1994): Presented by Cynthia S. Blasses November 25, 2002

Introduction and Objectives Theoretical paper exploring impact of major shocks in the rental housing market Develops a structural dynamic model of simultaneous equations –demand –supply –construction –asset price

A Perfect Foresight Model Formulation of expectations Equations link price with future expected rents Manipulating the equations- –Future values are eliminated using only current & lagged values of rent & price P t represents the present value of actual future path of rents

Model Equations R t = a 0 + a 1 K t + a 2 Y t (Demand) Parameters a 0, a 2 > 0, Parameter a 1 < 0 K t = (1-d)K t-1 + C t (Supply) C t = α(P t - P*) (Construction) (Price)

The Solution To solve this system of linear simultaneous difference equations, Alm and Follain develop a second-order difference equation E = R t + D 1 R t-1 + D 2 R t-2 Where it is assumed that Y t = Y t-1 = Y t-2 = Y T

Where the particular solution represents a steady state value for rent And the characteristic roots (b 1, b 2 ) determine the dynamic behavior of rent over time.

Adjustment Paths The adjustment path of rent depends on b 1 & b 2 The path oscillates over time D 1 >0, D 2 <0 Convergence to steady-state requires b 1 & b 2 to be less than one in absolute value Speed of adjustment is affected by many factors –in general, the smaller the characteristic roots, the faster the market converges to equilibrium

Concluding Recommendations Additional structure –Demand & construction equations derived from intertemporal utility and profit maximization Alternative expectations models should be explored –Specifically, a Rational Expectations Model Actual estimation of one or more of the equations presented –Econometric estimations of model parameters