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when the rent-price ratio of housing gets too large the whole market is at disequilibrium.

Many studies try to test directly the relationship of rent-price in a manner similar to that of dividend-price ratio in the financial literature (Case and Schiller 1988, Clayton 1996). This approach uses present value models and has the advantage of not requiring the specification of user cost of housing or market price of house services. However, Badev (2006) argues that one of the drawbacks of this approach is that the relationship between prices and rents is typically affected by supply restrictions, regulations and contractual practices that are not easily captured by the standard asset financial models.

In their recent work Campbell, Davis, Gallin and Martin (2009) find a number of interesting similarities between house markets and financial markets, although they are both quite different in both form and function. According to their paper the understanding of structural links between housing and financial markets is likely to be 'a fruitful area of future research'. In their study they use the applications of the dynamic Gordon growth model to the housing market. Moreover, the paper provides an insight into the fundamental sources of variability in housing valuations. Aside from providing direct evidence on the nature of fluctuations in rent-price ratio, the framework they adopt allows for a meaningful comparison of housing and other financial assets. The model used in their work splits the rent-price ratio into the expected present discounted values of rent growth, real interest rates, and a housing premium over real rates. They show that housing premiums are variable and forecastable and account for a significant fraction of the rent-price ratio volatility at national and local levels for the US, and that covariances among the three components damp fluctuations in rent-price ratios. Thus, the explanations of house-price dynamics that focus only on interest rate movements and ignore these covariances can be misleading. The results they obtain are similar to those observed for stocks and bonds.

Badev (2006) uses three different approaches in his paper to provide evidence for the relationship between house prices and rents in the United States. The third analysis provides the most conclusive evidence that house prices correct back to rents. In his analysis he uses bootstrap procedure to construct artificial data that conform to his null hypothesis that rents and prices are cointegrated, but that rents do all the correcting. Additionally, the newly constructed artificial data is used in a long-horizontal regression analysis to examine how the rent-price ration is related to changes to real rents and prices over three-year horizons. Furthermore, expectations would suggest that rents will 'correct' much faster than they do in the data. In addition, the data shows a positive correlation between the rent-price ratio and real house prices instead of what we would expect, which is a negative coefficient. These results provide evidence against the null that rents do all the correcting and that prices do none. Studies like Badev (2006) suggest that the rent-price ratio is a reasonable measure of the valuation of the market. However, the paper takes into account that it needs better measures of house prices and rents to fully understand their relationship and also that it essentially ignores potential transa