Evaluation of the house price models using an ECM approach: the case of the Netherlands

The research question of this paper is whether the Dutch housing market isovervalued or not. This is investigated by using different types of error correctionmodels and by examining the impact of different variables that can explain houseprice changes in the Netherlands. The current financial crisis confirms the notion thatdevelopments in the residential property sector are important for the economy as awhole. For that reason it is important to fully understand the factors that affect thehousing market. Therefore we need a long-run model approach that relates houseprices to fundamentals. However the model should also be able to detect bubbles inthe short run. As a first step, we look at the affordability of house prices and mortgagepayments in order to check how well the housing market performs in the short run. Inthe medium to long-run run, we estimate an error correction model relating prices tofundamentals, using variables like interest rate, labour income, financial assets ofhouseholds, and household stock. The error correction model tests whether pricestend to revert to some equilibrium price level. We evaluate existing house pricemodels for the Netherlands, which we use as a benchmark for comparison to ourimproved model. Finally, we try to forecast housing prices based on a few simpleeconomic scenarios.Keywords: Bubble, Co-integration, Error-Correction Model, Long-run Equilibrium.