Abstract
In this article, we want to investigate that there is money illusion or not in the housing market. Money illusion is also called inflation illusion, which means people assume the expected inflation rate is constant, and then mistakenly think the real value of assets has changed. This misperception will cause the irrational behavior in investment and consumption. Money illusion hypothesis indicates that the mispricing of asset is mainly influenced and caused by the inflation rate, and there is significantly negative correlation between mispricing and inflation rate. We choose England, one of the world's greatest economies, to be the research objective, and the sample period is from 1990 to 2017. We try to separate the mispricing component, the deviation from fundamental value, from the price-rent ratio, and use the Bayesian Vector Autoregression to get the estimated value of mispricing, then take the mispricing to run Least Squares model with the inflation rate. In our results, we don’t find any evidence to support money illusion hypothesis, so we try to find another variable also representing the irrational behavior of investors can better explain the mispricing. We choose consumer sentiment to be the another factor to compare with inflation rate. Finally, we confirm that consumer sentiment can better interpret the mispricing component of asset than inflation rate.