Investor Rationality and House Price Bubbles: Berlin and the German Reunification

(together with Rainer Schulz), German Economic Review 11, 2010, 465-486


We analyze the behavior of investors in the Berlin rental apartment house market over the years 1980–2004. Using constant-quality multipliers (pricerent ratios), we reject the hypothesis that multipliers in the market were set in a rational manner. Supported by narrative evidence, we conjecture that investors misjudged the economic effects of the German reunification. To examine this, we employ a stylized structural economic model and analyze the effects of shocks on rational multipliers. It seems that investors confused the reunification with a permanent supply side shock to the economy. By basing their investment decisions on this misjudgement, investors behaved irrationally, but in a very uncertain and unprecedented environment.

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