__kolbe__

How do you define over or undervalued? What analysis do you use to determine value?

What does that mean, though? I see a small attempt at defining value, but I'm not getting much out of it.

Fundamental value is based on supply, demand, and realistic expectations about the future. We all learned in Economics 101 that prices move back toward an equilibrium determined by fundamentals of supply and demand.

So, value is a price to which you believe homes will move towards over some period of time? So, when you say homes are undervalued by 5%, you're saying that you predict a 5% appreciation in home prices over some period of time?[1] What about after that time? Does this include broker commission? What are the catalysts for prices to either exceed this expected 5% gain, and what would cause them to not to realize?

How does the macroeconomic environment, monetary policy and federal GSE policy shape home value going forward? Will what impact will fed tapering have on "equilibrium" price-to-rent ratios? What timeline do you forecast fed MBS purchases to cease by? Will Yellen be selling MBSs, even?

I see the calibration period for your data set starts in 1991? That whole period is essentially a declining-rate period with heavy GSE intervention and >4% GDP up until the financial crisis. Does this mean you believe these things will continue to be present in the future for homeowners to rely on?

[1] What period of time?

The typical approach is to create a term structure of rent gains that converges to the long-term risk-free rate. That is, if you think rents will be going up by 5% in the short-term and the long-term risk-free rate is 3%, you could model rent increases with f(t)=0.05 *exp(-a * t)+0.03 * (1-exp(-a * t)), or any one of some set of functions where f(infinity)->risk-free rate. And like you said there is considerable difference when you consider stochastic rents and consumer utility of risk (...good luck). Especially in the US, where you can lever yourself HARD into a housing bet that rents will move up or stay the same, so that you win big when they do go up but declare bankruptcy, sticking the bank/Fannie/Freddie/AIG/Hedge Funds/Fed with the losses, if they don't (hint: use DCF with rents following a geometric Brownian, then run MC simulations on value, but with optionality at 0).

I appreciate your model and effort, but introducing this model is just indirection. I'm curious about forecasting home values in the context of the fundamental economic changes we may or may not see. Your model just passes the source of value from forecasting market home prices to forecasting market rents. The latter is no easier to determine than the former.