Journal of Development Economics 39 (1992) 111-139.

North-Holland

The dynamics of real asset prices, the

real exchange rate, trade reforms and
foreign capital inflows
Chile, 1976-l 989*

Felipe G. Morandk
ILADESIGeorgetown University. Santiago, Chile

Received March 1991, linal version received September 1991

This paper explores the dynamics of real asset prices in Chile in the last 15 years, in a
framework where a central role is played by the real exchange rate, tariffs, and foreign capital
inflows. Working with time series models, the real prices of land, capital (stocks) and housing,
the empirical results show that, at a time when structural reforms took place (19761982),
including a trade liberalization, tariffs contributed significantly to explain the real price of land,
while macroeconomic conditions were dominated by foreign capital inflows. After 1982, the real
exchange rate plays a key role in many respects.

1. Introduction

As is now well known, the Chilean economy went through a number of

profound structural reforms in the second half of the 197Os, ranging from the
trade regime to the social security system, and including changes to a strict
labor law, an initial liberalization of domestic prices (most of which were
previously set by a state agency), a liberalization of the financial system, a
tax reform, privatization of state-owned enterprises and others of less
importance. On top of this, the reforms were presented to the public opinion
as a comprehensive package to transform Chile’s economy to a private-
sector, free-market one, in which property rights were to be fully respected.
At a time when several developing countries are trying to apply or in the

Correspondence to: Dr. Felipe G. Morandb, Economics Department, ILADES/Georgetown

University, Almirante Barroso 6, Santiago, Chile.
*Presented at the Fourth InterAmerican Seminar on Economics, Santiago, Chile, March 1991.
A previous version of this paper was prepared while the author was consulting for the Trade
Policy Division of the World Bank. However, the views expressed in the paper do not
necessarily represent those of the World Bank. Thanks are due to Rambn Lbpez for encouraging
this research and providing many insights, to Felipe Lagos and Jorge Quiroz for comments, and
to Raimundo Soto for excellent research assistance and comments. An anonymous referee of this
Journal also made extremely helpful suggestions and comments. As usual, any remaining errors
are my own.

0304-3878/92/%05.00 0 1992-Elsevier Science Publishers B.V. All rights reserved

112 F.G. Morandh, The dynamics of real asset prices in Chile

process of applying similar reforms, it seems interesting to look at the more

than a decade long Chilean experience in many senses. The key issues
pertain, naturally, to the appropriate depth, timing and coordination of
reforms judged based on the economy’s overall performance, particularly in
terms of levels of activity, unemployment rates and, sometimes, inflation
rates. Central to changes in these variables is the behavior of relative prices,
both of goods and factors, with the consequent effects on the supply side of
the economy. In the case of Chile, it is easy to see the significant effects on
relative prices of goods, originating in the reforms, simply by observing the
corresponding time series. Similarly, there are many accounts on the reforms’
effects on the production side of the economy [Coeymans and Mundlak
(1990), Edwards and Cox-Edwards (1987), Krueger (1988) among others].
Yet another way to look at most of the same key issues is to investigate
the extent to and the timing in which prices of production factors are
affected by the reforms and other significant macroeconomic policies. Indeed,
the evolution of factor prices might tip on the speed of adjustment of
different sectors and, thus, on the social cost associated to the transition
coming after the reform is implemented. Along with labor, services derived
from real assets - like land, some natural resources, and capital - are key
production factors. Prices of these real assets, thus, may convey information
on the reforms’ effects that we are looking for. At the same time, however,
such prices are also related to people’s portfolio decisions and, as such, can
be related to other macroeconomic and financial variables that are not
usually considered when discussing economic reforms, like real wealth; or can
be related to the same macroeconomic variables - like the real interest rate
or the real exchange rate ~ in a more complex manner. To learn about this
type of information is that the present paper implements the empirical work
that follows.
More specifically, the paper tries to stress the dynamics of real asset prices,
but in a framework where a central role is played also by the real exchange
rate, tariffs, and foreign capital inflows. In this respect, three distinctive policy
elements crucial to the understanding of the evolution of the Chilean
economy in the last decade and a half, are taken into account: the exchange
rate policy, the trade liberalization policy, and policies (if any) affecting
foreign capital movements.’ In a sense, the three policies involved both
structural reform elements - this is clearer in the case of trade liberalization
and financial opening up - and typically macro policies - this is clearer in
the case of exchange rate policy.
The empirical work concentrates on the prices of three real assets: land,
capital, and housing. The first two are chosen because of their derived role as

‘There are several works that one way or another treat, empirically and theoretically, the
influence of these variables on several others. Among others, Barandiaran (1988), Corbo (1983),
Edwards (1988), Morandk (1988), and Morandk and Schmidt-Hebbel (1988).
 F.G. Morandk, The dynamics 01 real asset prices in Chile 113

production factors. The choice of land, in particular, obeys to their intensive

use in Chile’s agricultural exportable products, while capital is chosen
because it is an important factor in the production of tradeable goods. Since
land and capital are real assets that are also present in people’s portfolios, it
is only natural to complete the set of asset prices with the price of housing.
Housing services, however, can also be considered a type of consumption
good.
In spite of the development and presentation of a simple theoretical
framework in section 2, the paper stresses much more the empirical relations
that result from measurement than the novelty of the theoretical model itself.
Moreover, the empirical models estimated contain many free parameters in
the sense that only loose restrictions - like the type of variables that should
go in each equation, which is motivated by the theoretical model - are
imposed on the empirical relations between all series involved. In other
words, the strategy followed in this paper lies much closer to the ‘measure-
ment without (too much) theory’ tradition of time series analysis than in
other more classical econometric approaches that try to look for specific
values of parameters and elasticities that are previously derived from theory.
Apart from section 2 and the simple theoretical model, section 3 presents
the main empirical results, while section 4 concludes.

2. A simple theoretical framework

As explained above, we try in this section to rationalize the sense in which

the variables that constitute the empirical models of section 3 could be
linked from a theoretical point of view. In contrast, no attempt is done in
order to derive from theory the sort of complex dynamic relations that are
estimated in the time series models below.
In building a (simple) theoretical setup for the chosen assets’ prices - land,
capital, and housing - we take into account that they face two types of
(related) demands: as non-perishable goods, there is a demand for each of
them as stores of value; but simultaneously, these assets also have intrinsic
value, either because they (their services) are used as production factors - the
case of land and capital represented in stocks - or because they are a durable
consumption good - the case of housing. In what follows, we first model the
demand for the assets’ services and derive expressions for the prices of such
services under simplifying assumptions. Then, the prices of services are linked
to the corresponding assets prices in a way that incorporates, at this point,
the portfolio nature of decisions concerning the exchange and holding of
assets.
Land is a natural resource intensively used in the production of Chile’s
exportable goods. Let’s assume that the production of the representative
exportable good is guided by a cost function of the type
114 F.G. MorandP, The dynamics of real asset prices in Chile

WY p,, X) = XU@(W,
PA (1)

where X is the exportable good, W is the wage rate, P, is the user cost or
user price of land, and u is the marginal elasticity of the marginal cost with
respect to production of X.’ Since the cost function is homogeneous of
degree one with respect to factor prices3 we can deflate both sides by a
price deflator, which we choose to be the price level P, and express ‘real’ cost
as a function of ‘real’ factor prices:

C,( . )/P = Xw( W/P, PJP). (2)

If the exportable firm takes prices parametrically, then it will produce

where marginal cost equals the given price. In log terms and by virtue of the
linear homogeneity of @( .),

lncc+(cc-l)x+uw+(l-u)p,=p,, (3)

where lower case latters represent variables in logs, px is the (log of the) real
price of exportables (in domestic currency), and the term u is less than or
equal to one and reflects the elasticity of substitution between labor and
land.
Either by assuming constant returns to scale (CI= 1) or the small open
economy assumption, eq. (3) could be simplified to one in which the real user
price of land is expressed as

p,=[l/l-u]p,-[u/l-u]w. (4)

The relation between the asset price of land (PL) and the user price of land
is assumed to be given by

P~=~(P;,P;,~,z)P,; e,,e2,e3<o, e,>o, (5)

where PE is the expected (real) price of capital (stocks), Pi?, is the expected
(real) price of housing, I is the real interest rate, and Z is a measure of real
wealth. In eq. (5), the function 8 reflects how the asset price of land could
differ from a linear relation with respect to the user price of land as portfolio
considerations are taken into account. A log-linear approximation of eq. (5),
where p, is replaced by its expression in eq. (4), would be:

(6)
*The value of LXwill indicate whether there are constant (a= l), increasing (a< 1) or decreasing
(a> 1) returns to scale.
3And so it is the function @( .).
 F.G. Morande, The dynamics ofreal asset prices in Chile 115

where a,, a,, a,, a6 5 0,4 while a4, a5, 2 0.

In the case of the price of capital, as measured by stock prices, an
expression analogous to (6) is easy to derive, but now the real price of
tradeable goods will substitute the price of exportables, as capital is used
both in the production of the latter as in the production of importable
goods.’ That is,

ps=b,+blp;+b,p;+b3r+b4z+bsp,+b6w, (7)

where pE is the expected real price of land and pt is the real price of
tradeable goods (in domestic currency). As in eq. (6), b,, b,, b,, b, SO, while
b,, b, 2 0.
In the case of housing, the derivation is slightly different since housing
services are mainly a consumption good rather than a production factor.
Let’s assume that the representative household consumes three types of
goods: the already mentioned housing services, an importable good, and a
composite, mostly non-tradeable, good, whose price, the consumer price
index, is assumed to be the numeraire. It is easy to show that, under regular
assumptions with respect to preferences and a tixed available stock of
housing, the market-clearing price of housing services in this set-up could be
expressed as a function of real income and the real price of importables. In
this framework, the derivative with respect to real income will be non-
negative but that with respect to the real price of importables will depend in
sign on whether housing and the importable good are substitutes or
complements. In any case, if we again assume, as in the case of the price of
land and the price of capital (stocks), that the price of housing services and
the asset price of housing are related by a variable coefficient that reflects
portfolio decisions, then we end-up with an expression for the asset price of
housing like

(8)

where c1,c2, c3 SO, c4,cgz0, and cs either 2 or < than 0; and pm is the (log
of the) real price of importables and y is real income.

The macro variables

Eqs. (6), (7), and (8) summarize the behavior of assets’ prices in a sort of
partial equilibrium set-up. Apart from the expected prices of themselves,
there also appear, either explicitly or implicitly, some macroeconomic

4The coefficients concerning portfolio decisions in this equation and in equations correspond-
ing to assets prices below, are assumed to satisfy gross asset substitutability and the cross-
equation restrictions on parameters consistent with the Brainard-Tobin adding-up constraints.
‘As for non-tradeable goods, we assume that their production is based mainly on labor.
116 F.G. MorandC, The dynamics of real asset prices in Chile

variables that deserve special attention since their effects on real assets’ prices
constitute the core of the empirical work that follows in section 3. In
particular, and given the generally accepted importance they have been
attributed in the Chilean economy of the last two decades, we are concerned
with the real exchange rate, import tariffs, and foreign capital inflows.
In all three equations (6) to (8) there is a version of the real exchange rate
(RER) as an explanatory variable. We assume, for the sake of the empirical
estimation, that in the three cases there is a common pair of variables that
reflect real exchange ‘elements’: a variable defined as the nominal exchange
rate multiplied by a foreign price index and deflated by the domestic CPI (a
‘measured’ real exchange rate); and an index of import tariffs. In the case of
eq. (6), for the price of land, this pair as a proxy of the real price of
exportables is justified on the need to capture the effects on domestic terms
of trade, and so in the price of the real user price of land, of changes in
tariffs that are not fully reflected in the measured RER. The expected effect of
these changes in tariffs on the real price of land is negative, ceteris paribus,
as a decrease in tariffs will bring an increase in PJP,, and so an increase in
P,/P for unchanged non-tradeable prices.6 In the case of eq. (7), for the
price of stocks, the justification of the proxy is more straightforward.’
However, the effect of changes in tariffs is ambiguous since to the positive
direct effect that follows from the definition of the measured RER vs the
domestic price of tradeable relative to non-tradeable goods, an uncertain
effect brought by the decomposition of stocks in exportable and exportable
activities is opposed. In the case of eq. (8), for the asset price of housing, a
reasoning similar to the one done for the case of land is applicable. The
effect of changes in tariffs on the price of housing will be greater, equal or
less than 0 depending on whether housing and the importable good are
substitutes or complements on demand.
Tariffs are taken to be truly exogenous from the outset, as they reflect a
deliberate policy tool to implement the trade liberalization aiming for a long-
run transformation of domestic relative prices that was mentioned in the
Introduction. The measured RER is instead assumed to be a function of
other variables. Following Edwards’ (1989) intertemporal theoretical frame-
work, such set of other variables could include international terms of trade,
import tariffs, domestic and foreign interest rates, and foreign capital inflows.
The latter variables can reflect both demand for foreign credit conditions -
including government controls - and supply of foreign funds. The demand
for foreign credit will be guided by the same variables in the RER equation,

6Remember that P is the consumer price index and, as such, includes both non-tradeable and
tradeable mainly importable goods.
‘The ‘measured’ RER does not include tariffs, so in proxying the domestic price of tradeable
goods it is only natural to include such tariffs as an additional variable.
 F.G. Morandk, The dynamics of real asset prices in Chile 117

plus the RER itself. The supply of foreign funds, instead, will be assumed to
be essentially exogenous.
But foreign capital inflows will not only affect the RER. As several authors
have suggested [see for example Barandiaran (1988), Schmidt-Hebbel (1988),
and Morande and Schmidt-Hebbel (1988)], an easy access to foreign credit
can have a positive effect on ‘perceived’ real wealth or permanent income, as
people believe that now they are not financially constrained to smooth out
consumption. If, as it was the case in Chile during the sample period, foreign
capital inflows experience extreme variations that dominate the effect of any
other variable on perceived wealth or permanent income, then one can even
postulate foreign capital inflows as the only relevant proxy of the latter
variable.’ This way, foreign capital inflows would enter directly in eqs. (6)
to (8) as an explicit explanatory variable.

3. Main empirical results

To have a glance at the type of data series we will be working with, in fig.
1 we present graphs for the three asset prices considered for the period
spanning January 1975 to December 1989. The series presented are three-
month moving averages of the raw data.
The raw data for the case of land and housing prices, in turn, were
constructed by the author according to a procedure described in the
appendix.’ In the case of land prices, we were careful in taking information
on farms in the central zone of Chile and with soil appropriate for growing
exportable products, like fruit of several kinds. In the case of housing prices,
we considered a medium to high class urban county of the Great Santiago
metropolitan area, with a slow new construction rate and a relatively
homogeneous type of residential housing.
Data for stock prices were taken from public stock markets sources. The
particular series chosen was the ‘Indice General de Precios de Acciones’.
In looking at the time series presented in fig. 1, there seems to be a
structural change in the data occurring between late 1981 and late 1982,
depending upon the series. This should not be strange since that period
witnessed a profound economic crisis, with a negative GNP growth of almost
15% in 1982 and a further reduction of around 1% in 1983, with unemploy-
ment climbing as high as 30% in 1982 and with a doubling of the nominal
exchange rate in less than twelve months. While the crisis was triggered by a
complete stopping of foreign capital inflows at the end of 1981, it dramati-

‘Foreign capital inflows went from 263 million dollars in 1976 to more than 4.5 billion dollars
in 1981, then down to less than 500 million dollars between 1983 and 1986, and up again to
close to 1.5 billion dollars in the last two years.
‘There was no alternative since data for these prices did not exist in Chile for such a period.
 118 F.G. Morande, The dynamics of real asset prices in Chile

REAL STOCK PRICE

3.MONTH
MA

75.03 77:01 79:03 SI’O3 Z33:03 85ll3 81-03 8903

REAL PRICE OF LAND

3.MONTH
MA

75:03 77:03 79:03 a,:03 IS,:03 85:03 mo, 89:03

REAL PRICE OF HOUSING

3-Mowni MA
450 -- -~~~~

50 L... : : .--I
7503 ,703 79:03 81:03 s3:03 85:03 ST:03 x9:03

Fig. 1. Real asset prices.

tally worsened the financial system health, which entered in deep trouble
during 1982.”
The first part of the sample period, from 1976 to 1982, was marked by two
main events. In the first place, the bulk of the structural reforms mentioned before

“‘There are many accounts on this crisis period. See for example Edwards (1988), Corbo
(1983), Morandi and Schmidt-Hebbel (1988), Barandiarin (1988), Hachette (1989), and Morandt
(1991).
 F.G. Morandt!, The dynamics of real asset prices in Chile 119

took place. And second, huge amounts of foreign capital flew in between
1979 and 1981, coinciding with a fixed exchange rate policy and 100%
indexation of nominal wages. The accumulation of foreign debt was judged
‘excessive’ by foreign lenders after the Mexican crisis and some bank failures
within Chile. Consequently, foreign capital inflow ceased almost completely
and the extremely difficult foreign position led authorities to massive
devaluations in order to facilitate the needed increase in the real exchange
rate. This fact, plus the normalization of the financial system (which included
the bailing-out of many domestic debtors financed with Central Bank
resources)” and a sound macroeconomic management that led to a
sustained recovery of activity and investment, characterized the second part
of the sample (1383-1989).
To test whether there was a structural change, we run regressions for each
of the asset prices series (in logs) with respect to a constant (mean) and a
trend,” in order to check for instability in the estimated coefficients in the
‘neighborhood’ of early 1982. This regression was estimated recursively. The
idea is that if the recursive estimation presents breaks, inflexions or abrupt
changes in slope, then it means that starting at that date, the estimation
changes with new observations so the parameter is unstable because there is
a regime or structural change in the series. Naturally, few degrees of freedom
imply apparent instability early in the sample that cannot be interpreted as
structural change. As it is evident from the set of graphs in fig. 2, there is a
clear change in both coefficients (mean and trend) in early 1982 for both the
real price of land and the real price of housing. In the case of stock prices,
the change - again in both parameters - occurred during 1981.
Consequently with the previous results, we opt to separate the ‘model’
estimation in two sub-samples: one for the 1976-1982 period, the other for
1983-1989. The empirical analysis itself is built upon the innovation account-
ing techniques mainly developed by Sims (1980) and described in Litterman
(1979) and Fackler (1988). Based on estimated vector autoregression (VARs),
these techniques break down the variance of the forecast errors of a variable
into components due to each of a set of orthogonalized innovations of all
variables involved in the system. This also permits us to assess the
importance of each variable in explaining the behavior of others in sub-
periods within the full sample period, in what is known as historical
decomposition. But more interesting to us for the purpose of this paper, the
moving average representation of the estimated autoregressive system allows
the calculation of impulse response functions that record the dynamic nature
of the reaction of a certain variable to a shock in another variable. Much of

“This is a quasi-fiscal deficit. For ligures in the Chilean case, see Eyzaguirre and Larranaga
( 1990).
“The regression is: log X=x0 + K, t +p. where p is white noise.
 120 F.G. Morandk, The dynamics of real asset prices in Chile

RECURSIVE ESTIMATION OF nl IN STOCK SERIES

.I / , / .~T * ._-,~+__T____t__+.-l ,- ~--. __

76 77 78 79 H” 8, 82 83 84 85 86 87 88 89
__ RECURSI”E C(l) ESTIMATES ------ t- ZS.E.

RECURSIVE ESTIMATION OF I,1 IN HOUSING SERIES RECURSIVE ESTIMATION OF Ilo IN LAND SERIES

RECURSIVE ESTIMATION OF no IN STOCK SERIES RECURSIVE ESTIMATION OF nl IN LAND SERIES

0.8 -“\
ic
,
0.7 _ ‘,
0.6 I -\ \

0.4 i
L..-. ‘\L I

Fig. 2. Recursive estimations of q, and n,.

the reported work will be on the reaction of real asset prices with respect to
shocks in related variables.
n_::, LJ,upietely unrestricted - except for arbitrary lag length - and
,rtially restricted VARs systems were tried. The main restriction was the
inclusion of some variables a priori postulated as exogenous as deterministic
variables not influenced by the remaining of the system. Normally models
were estimated in log form, while variables that exhibit significant variations
 F.G. Morande, The dynamics of real asset prices in Chile 121

Table 1
Perron unit root tests.

Variable Perron
Log real price of stocks - 4.26
Log real price of housing - 5.48
Log real price of land - 5.28
McKinnon’s critical value: 1% = -4.56
5% = -4.25
Sample partition = 0.5

on a month to month basis were transformed with a three-month MA filter.

As it is already clear, the linear autoregressive systems were estimated with
variables based upon monthly data.
It is interesting to note that, if we accept the hypothesis of structural
change, findings concerning Perron unit root testsI and reported in table 1,
show that neither the log of the real price of housing nor the log of the real
price of land have unit roots at 1% critical values. In the case of real stock
prices, the unit root hypothesis is rejected at 5% critical values. This is
important because if all stochastic series involved in the estimation are I(O),
then any linear combination of them will also be Z(0). This will allow us to
estimate our VAR linear system in (log) levels rather than in first differences.
In terms of the simple model presented in section 2 above for asset prices,
there are some aspects to be solved before the empirical analysis. In first
place, the expected prices of assets that appear in eqs. (6) to (8) are not
observed variables, so we make the assumption (consistent with our estima-
tion technology) that they simply are log-linear functions of past values of
themselves.14 Secondly, the estimated VAR systems include lagged values of
all dependent variables although this is not directly derived from eqs. (6) to
(8). We can justify this modification on the grounds that it permits a more
dynamic empirical analysis that accounts for off-steady state equilibrium
situations. Thirdly, most ‘macro’ variables in the systems are assumed non-
stochastic or deterministic, while real asset prices are all assumed stochastic.
This means the imposition of some Granger-priors (from macro variables to
real asset prices). And fourthly, macro variables considered are the RER,
foreign capital inflows, import tariffs, real wages, and domestic real interest
rates. Non-reported results and some previous findings elsewhere” induced
us to disregard international terms of trade and world interest rates.

‘-‘This test is more. adequate than others like Dickey-Fuller or Augmented Dickey-Fuller for
cases in which there is a clear change in trend, as we postulate here according to our previous
recursive estimations.
r4The coefficients on lagged values are not restricted and are estimated jointly with the whole
VAR system.
“See Morandi (1988).
122 F.G. MorandP, The dynamics of real asset prices in Chile

3.1. The 1976-1982 period

The empirical model suggested for this period considers a VAR system
with the three real asset prices (defined as the asset’s nominal price in
Chilean pesos divided by the domestic CPI), the real wage (defined as the
general index of wages divided by the CPI), an index for average tariffs,
foreign capital inflows (defined here as capital inflows approved under Article
14 of the Chilean law of foreign exchange),i6 a real domestic interest rate
(commercial banks lending rate less actual variation in the domestic CPI), a
constant and a time trend. We omit the RER on the grounds of some
previous work” that established that foreign capital inflows were exogenous
with respect to, and Granger-causative of, the real exchange rate for the
19761982 period. In other words, the inclusion of the RER in the system
would not convey any new information that was not already included in
foreign capital inflows.
In the estimated VAR system, only the three real prices of assets are
assumed stochastic, while the real wage, tariffs, capital inflows, and the
domestic real interest rate are assumed deterministic. We then are taking for
granted that any (Granger) causality relationship must go from these
deterministic vector of variables to real prices of assets and not in the
opposite direction. In the particular case of foreign capital inflows this is
documented in Morande (1988).
Lag lengths were tested under the restriction that they could not be longer
than 8 lags to avoid having ‘too many’ free parameters to estimate. Using
Chi-square tests an optimal lag length of 6 was chosen for the system.
Table 2 presents the F-tests for checking whether the null hypothesis that
the block of lag-coefficients of each variable is zero in explaining the
behavior of real prices of assets. As can be observed, (the block of six lags of)
foreign capital inflows turn out to be the most influential variable on real
asset prices, being significant at the 5% level for all three equations.
Meanwhile the trade reform as reflected in the (six-lag block of the) tariff
variable was, as expected, important in explaining the real price of land (less
than 1% significance level), and somewhat in the equation for the real stock
price index. Interestingly, the (six-lag block of the) domestic real interest rate
and the (six-lag block of the) real wage do not seem to be influential. Real
asset prices do not appear to affect each other very significantly. Indeed, only
the real price of land appears to have some (marginal) influence on the real
price of stocks. However, this is not yet conclusive evidence that portfolio
considerations spelled out in the previous section are not important.
According to these results, we excluded both the domestic real interest rate

16This has been the main vehicle for channeling short run foreign capital inflows since its
inception in 1976. For more details, see Corbo (1983).
“Morandi (1988).
 F.G. Morandd, The dynamics of real asset prices in Chile 123

Table 2
F-tests for blocks of lags.”

Dependent variable (equation)

Independent variables LAND HOUSING STOCKS
Tariff 3.31 0.21 1.97
(0.009) (0.956) (0.096)
K inflows 2.84 2.25 2.91
(0.021) (0.050) (0.018)
Real interest rate (RER) 1.53 0.39 0.61
(0.184) (0.747) (0.721)
Real wage 0.55 1.82 0.92
(0.682) (0.113) (0.510)
Real price of land (LAND) 12.35 1.11 2.22
(0.W) (0.335) (0.059)
Real price of housing (HOUSING) 0.66 31.72 1.49
(0.635) (0.000) (0.211)
Real price of stocks (STOCKS) 1.61 0.42 113.57
(0.172) (0.871) (0.000)
“Signilicance levels at which the null hypothesis is rejected in parentheses.

Table 3
Variancecovariance and correlation matrix.a

LAND HO USING STOCKS

LAND 0.132 0.069 -0.106
HO USING 0.001 0.006 -0.043
STOCKS 0.001 -0.000 0.001
“Values on and below diagonal correspond to elements in the variance-
covariance matrix. Values above diagonal represent the corresponding
correlations.

and the real wage from the vector of deterministic variables in estimations
run to carry out the innovation accounting technique. Also, since the
ordering of variables in the system could be an issue in the application of
such a technique if there are signs of contemporaneous correlation, we paid
special attention to the variance-covariance and correlation matrices.”
However, as table 3 shows, no significant contemporaneous correlation
appears to exist between the three variables representing real prices of assets.
Therefore, the ordering of variables (real asset prices) in the system is not
important.
The next step is then to look at the exercise of variance decomposition.

‘*The ordering is important since the orthogonalization of innovations is built on the

contemporaneous correlation. If this is large, significant variations between innovation-
accounting exercises based on different orderings might be expected.
124 F.G. Morand6, The dynamics of real asset prices in Chile

Table 4 shows the percentages of the forecast-error variance of a variable

explained by innovations in itself and the remaining variables in the system
for an arbitrary ordering that places the price of land in first place, the real
price of housing in second place, and finally the real price of stocks.
In explaining the forecast error of the real price of land, both tariffs and
foreign capital inflows play a significant role after 24 months: they jointly
explain close to 35% of variation. Real stock prices also appear as an
important variable, accounting for over 20% of the forecast-error variance of
the real price of land.
The real housing price is closer to Granger-exogeneity since after 24
months, shocks to itself explain more than 50% of its own variance.
However, a shock to foreign capital inflows reaches almost 20% of explana-
tion of the real housing price in the same number of months, while
something alike occurs with a shock to real stock prices. The role of (a shock
to) tariffs is neglectable, meaning that changes in the domestic terms of trade
between exportable and importable goods do not significantly affect the price
of housing.’ 9
In the case of the forecast error variance of the real price of stocks, again
(a shock to) foreign capital inflows looks as the single most relevant variable,
explaining almost 30% after 24 months. Tariffs play a lesser role, although
still can explain up to 10% of real stock prices.
In general terms, the variance decomposition exercise tends to confirm the
prominence of foreign capital inflows in explaining the behavior of real asset
prices before the crisis previously found with the F-tests for blocks of lags.
The important role of tariffs with respect to land prices and stock prices is
also reinforced.
A further exercise, as anticipated, is to take a look at the impulse response
functions generated by the moving average representation of the estimated
system. If we have already found that foreign capital inflows and tariffs are
important in explaining the real prices of assets, the impulse response
function will allow us now to learn the dynamic nature of these relationships.
In technical words, what is done is the plotting of the responses of the log of
the analyzed variable to a unit positive shock to the log of the remaining
variables in the system.
In analyzing the dynamic behavior of the real price of land, capital inflows
seem to have a strong negative impact during the first five months after a
shock, but also some reduced positive effect after a year, as can be deduced
from fig. 3b. A possible interpretation could be that the negative impact
during the first five months reflects the negative impact that a positive inflow
will have on the real exchange rate, which in turn, and according to section 2

“Remember that housing and the importable good could be either substitutes or comple-
ments in our set-up.
 Table 4
Decomposition of variance model for period 1976: 1 to 1982: 12.

Innovations in
Months
Explained variable after shock Tariffs K inflows LAND HO USING STOCKS
Real price of land (LAND) 6 5.14 23.66 61.20 4.86 5.13
12 16.88 17.19 47.87 6.20 11.86
18 15.83 17.41 43.52 5.75 17.48
24 16.8 17.89 38.08 5.14 22.09

Real price of housing (HOUSING) 6 0.16 4.76 6.08 83.76 5.23

12 0.50 9.10 7.81 73.57 9.02
18 1.13 17.12 6.70 59.38 15.66
24 2.86 18.53 6.90 53.99 17.72

Real price of stocks (STOCKS) 6 3.16 28.99 2.07 4.54 61.23

12 4.20 26.86 5.65 11.95 51.34
18 7.16 25.80 6.84 11.88 48.32
24 10.31 27.80 6.50 11.42 43.98
126 F.G. Morande, The dynamics of real asset prices in Chile

RESPONSES OF LAND PRICES TO

SHOCK TO HOUSING PRICES SHOCK TO K INFLOWS

197CIP82 L97.5
1982

G.5-~
0.4+ a
0.3 I

PERIODS Am!3 SHOCK PERIODS AFTER SHOCK

SHOCK TO STOCK PRICES SHOCK TO TARIFFS
19161982 19761987

above, will reduce the real price of land. The later positive effect, although of
less statistical relevance, could reflect the effect of greater credit availability
on perceived wealth, which, in turn, brings the increase in the real price of
land.20 In any case, this positive effect could have showed up right after the
shock, but apparently it was overshadowed by the strong impact of the
capital inflow on the real exchange rate and the implicit effect of this on the
real price of land.
Another interesting result comes from looking at the dynamic effects on
the real price of land of a shock to tariffs, shown in fig. 3d. There we can see
that an increase in tariffs has a significant negative impact but only after six
months. One could interpret this as evidence in favor of a hypothesis stating
that agents did not believe at once that the tariff reduction program
implemented since 1975 was not going to be reversed. Alternatively, another
interpretation could mention that adjusting land to different uses after
changes in relative prices is costly and takes time, and thus, the price of land

“This effect is summarized in the parameter a4 in eq. (6).

 F.G. Morandi, The dynamics of real asset prices in Chile 127

Fig. 4. Responses of stock prices.

will adjust only sluggishly. It is hard to discriminate between the two

interpretations based on the present evidence, but one can say in favor of the
first one that asset markets could quickly react to perceived investments with
high potential, at least much quicker than any physical adjustment of the
production asset itself.
The real price of land also shows sensitiveness with respect to a shock to
real stock prices (see fig. 3c), as anticipated in the variance decomposition
exercise. The bulk of the effect occurs more than seven months after the
shock and it is a negative response. That is, an increase in (expected) real
stock prices induce a negative reaction of the real price of land. As described
in the previous section, this could be interpreted as a result of agents’
portfolio decisions that consider stock and land as substitutes on demand.
In the case of real stock prices, a shock to capital inflows brings a
significantly negative effect for the whole first year after the shock (see fig.
4b). Again, as in the case of land, this could be interpreted as an indirect
effect operating through the impact of a positive capital inflow on the real
exchange rate and the negative impact that such a reduction in the real
128 F.G. Morandi, The dynamics of real asset prices in Chile

exchange rate would have on real stock prices. This interpretation agrees
with the simple theoretical set-up of section 2, which postulated that capital
reflected in stocks is essentially used in the production of tradeable goods.‘r
The effect of a shock to tariffs does not seem to be as significant as suggested
by the variance decomposition exercise; as evidenced by fig. 4d, it is positive
for three months after the third month following the shock and then turns
negative for almost a year. This mixed result is in agreement with our
theoretical prediction in order that changes in tariffs could have an
ambiguous effect on real stock prices, as tradeable goods contain both
exportable and importable industries. 22 It is also interesting to notice that,
as in the case of land, the most significant effect shows up more than seven
months after the tariff shock; whether this is somewhat an indication of the
credibility aspect of the tariff reform mentioned above will remain a
suggestion until further more conclusive tests are carried out.
The real price of housing shows to be most sensitive with respect to
foreign capital inflows, a result that was anticipated in the variance
decomposition exercise (see fig. 5a). The reaction to a positive shock in
capital inflows is strongly positive for about ten months, a fact that could be
interpreted as an indirect effect coming through the real exchange rate - the
hypothesized reduction in the real exchange rate that results after the
positive shock to foreign capital inflows would also imply an increase in real
housing prices. However, this interpretation means that housing and the
importable good are complements rather than substitutes on demand in our
model of section 2. But this is not corroborated by the neglectable effect of
tariffs in the price of housing. Fortunately, such a positive effect of foreign
capital inflows on the price of housing can also be interpreted as the result of
the greater perceived wealth that is brought by the greater availability of
foreign credit - a positive cq coefficient in eq. (8).
A final exercise consists in an historical decomposition of real asset prices
for the period between the outset of the crisis (early 1981), when foreign
capital was massively flowing into the country, to the end of 1982, when
foreign capital inflows had almost completely stopped. This stressing of
foreign capital inflows is motivated by our previous findings.
In technical words, an historical decomposition exercise separates a within-
the-sample projection of the endogenous variable variable (in this case, real
prices of assets) into two components: a ‘base’ projection formed exclusively
from information available at the time when the projection is made

*rIn Chile, during the 1980s between 65 and 70% of listed transactions in the stocks market
corresponded to what one could call ‘tradeable’ activities.
“With available information, it is not possible to classify listed stocks as corresponding to
exportable or non-exportable industries, as many of them - and some of the most important -
could be both simultaneously.
 F.G. Morande, The dynamics of real asset prices in Chile 129

RESPONSES OF HOUSING PRICES TO

SHOCK TO K INFLOWS SHOCK TO LAND PRlCES

197C1982 1!ncm?2

(December of 1980 in this case); and the difference between the base
projection and the actual series, which is, in turn, partitioned among the
innovations of all variables in the VAR system.
Figs. 6a and 6b show the result of this exercise for the case of the real land
price. As it can be seen shocks to capital inflows contribute significantly to
the explanation of the actual path of real land prices particularly during
1982, that is, when the stopping of the foreign capital inflow occurred. This
outcome could be interpreted as evidence of the strong effect the latter
variable had on the real exchange rate in 1982, especially after it forced a
number of devaluations.
A similar result holds for the case of the real stock price. Again, the main
contribution of foreign capital inflows tend to occur during 1982, when they
ceased to flow in.
The contribution of foreign capital inflows is less decisive in the case of the
real price of housing, although still a significant role is played by the second
half of 1982. Before that, shocks to itself account for almost 100% of the
difference between the actual series and the base projection.
130 F.G. Morandk, The dynamics of real asset prices in Chile

HISTORICAL DECOMPOSmOi-4 OF THE

REAL PRICE OF LAND SHOCK
,TO l-l-SELF
w31.1 - 19?217l

al/l m-J am am ah.9 au11 Q/l Q/3 am rm n.9 ltyll

-MTNN.- -BxiEmolEcl7oN -sHcxKlormLF

TO K INFLOWS
(19al.l- I%219
4.7 1
46-b

rln ab3 8115au7 am amI am 813 M m m a2n*

- ,
ACWwns-B~EPnO~~crc--zH-n,K-ws
Fig. 6. Historical decompositions of the real price of land shock.

3.2. A brief digression: The stock market price bubble

It is a common belief in Chile that a clear stock market price bubble

occurred in 1980, and that the vanishing of that bubble in 1981 was an
anticipation of the crisis that followed in 1982 and 1983.23 After learning of
the principal role played by foreign capital inflows during this whole period,
one can adventure a prominent role for explaining the bubble too. We apply
the historical decomposition exercise to the period elapsing from January of
1980 to December of 1981 and, as fig. 7 shows, found that actual shocks to
foreign capital inflows contribute as much as shocks to the real stock price
itself in explaining the actual evolution of real stock prices. Both shocks
together explain almost 100% of the difference between the actual series and
the base projection. Accordingly, one could say that foreign capital inflows

*%ee Meller and Solimano (1984) and Johnson (1990) for empirical accounts of such a
bubble.
 F.G. Morandb, The dynamics of real asset prices in Chile 131

THE STOCK PRICES BUBBLE (1)

HlSTONCALDECOMHISITTION

THE STOCK PRICES BUBBLE (2)

HISmORICAL
DEcomsmoN

so:1 803 805 803 803 P.o:1181:1 813 813 813 819 a:,,
- *muAL ------ SuMOFEFFEcrS

Fig. 7. Historical decompositions of the stock prices bubble.

fed much of the bubble, while ‘animal spirits’ embodied in the shocks to the
real stock price itself account for the rest.

3.3. The 1983-1989 period

Contrary to the 1976-1982 period, after the crisis the nominal exchange
rate has played a much more active role in affecting the real exchange rate.
The overall external payments situation of the Chilean economy starting in
1983 and up to 1986 was one that desperately called for a significant increase
in the real exchange rate. A policy of nominal devaluations was then
instrumental to facilitate such an increase.
On the other side, foreign capital inflows, as measured by Article 14 of the
Chilean law of foreign exchange, declined drastically between 1982 and 1985,
and remained low until 1987, when it again started to pick up. The other
variable we have been using, tariffs, experienced a flat increase to 200/, in
1983 (as a reaction to scarcity of foreign exchange), a further increase to
132 F.G. Mot-and& The dynamics of real asset prices in Chile

Table 5
F-tests for blocks of lags (model for 1983-1989).”

Dependent variable (equation)

Independent variables RER K inflows LAND HO USING STOCKS
Real interest rate 0.95 1.04 0.26 1.13 0.73
(0.463) (0.399) (0.881) (0.327) (0.564)
Real wage 1.89 0.29 1.08 2.01 0.92
(0.113) (0.907) (0.298) (0.078) (0.437)
Tariff 2.15 3.34 1.17 0.9 1 0.52
(0.068) (0.009) (0.333) (0.478) (0.791)
Real exchange rate 47.15 4.45 2.57 1.71 2.16
(0.000) (0.001) (0.037) (0.130) (0.063)
K inflows 3.01 15.67 2.36 1.71 0.67
(0.014) (0.000) (0.047) (0.139) (0.677)
Real price of 0.59 0.9 9.71 0.73 0.33
land (LAND) (0.712) (0.512) (0.000) (0.631) (0.919)
Real price of 0.56 1.34 0.69 22.35 0.63
housing (HOC/SING) (0.753) (0.262) (0.605) (0.000) (0.637)
Real price of 2.05 1.45 1.94 1.13 11.27
stocks (STOCKS) (0.078) (0.220) (0.099) (0.341) (0.000)
“Significance levels at which the null hypothesis is rejected in parentheses.

rates between 25 and 35% in 1984 (to raise fiscal revenues), and then a
reduction to 20% flat in 1985 and to 15% flat in 1986.
With these facts in mind, the empirical modelling strategy for the 1983-
1989 period is slightly different. We do not now presume that foreign capital
inflows are exogenous, but rather a variable to be explained by the real
exchange rate and real asset prices. The real exchange rate, in turn, is also
part of the stochastic system. We keep the assumption that the real wage,
tariffs, and the domestic real interest rate are deterministic variables (not to
be influenced by the rest of the system), but now they also are allowed to
influence foreign capital inflows and the RER.24
As in the previous case, the system was estimated linearly equation by
equation with all variables in log form - except the real interest rate - and in
levels2’ Chi-square lag-length tests were carried out which again indicated
six months as an appropriate figure.
Table 5 presents F-tests for the marginal significance of blocks of lags of
each of the variables involved. It is interestingly to note the important role
played by real exchange rate, whose blocks of lags are significantly different
from zero in the equations for capital inflows and the real price of land at

24With the exception of real wages, the other variables’ role in explaining part of the behavior
of the RER - and by extension foreign capital inflows - can be deduced from a model like
Edwards’ (1989) already alluded to.
“This is permitted by the Perron test results reported in table 1.
 F.G. Morande, The dynamics of real asset prices in Chile 133

Table 6
Decomposition of variance model for period 1983: 1 to 1989: 12.

Months Innovations in:

Explained after
variable shock RER KINF LAND HO USING STOCKS
Real exch. rate 6 75.46 8.37 11.53 0.68 3.96
(RER) 12 71.89 6.76 18.04 0.64 2.67
18 74.12 6.09 16.31 0.57 2.91
24 75.48 5.56 15.75 0.53 2.69
Capital inflows 6 10.23 69.27 13.22 2.23 5.05
(KINF) 12 12.88 57.55 18.29 2.75 8.52
18 14.77 53.44 17.69 2.58 11.51
24 15.31 52.78 17.34 2.54 12.01
Real price of 6 11.14 19.79 60.56 6.91 1.61
land (LAND) 12 16.76 21.46 43.00 10.78 7.99
18 16.66 20.68 41.53 10.67 10.45
24 16.68 20.48 41.01 10.60 11.24
Real price of 6 14.32 10.96 0.21 73.27 1.25
housing (HOUSING) 12 16.70 11.28 1.98 65.09 4.95
18 17.21 13.48 4.74 59.90 4.66
24 18.15 13.47 5.07 58.56 4.15
Real price of 6 10.58 8.97 0.78 7.91 71.77
stocks (STOCKS) 12 18.87 9.70 0.96 7.46 63.01
18 22.40 9.28 1.06 7.29 59.97
24 24.20 9.10 1.64 7.10 57.96

the 5% significance level, and in the real stock price equation at a 6%

significance level. Foreign capital inflows remain influential of the real price
of land, as in the 19761982 period, and appears important in the real
exchange rate equation. Blocks of lags of tariffs, in contrast, are significantly
different from zero only in the real exchange rate and foreign capital inflows
equations, but not in any equation for real asset prices. This could be
reflecting the erratic evolution of tariffs that characterized this sub-period, as
the increases had a balance of payments or a fiscal motivation - to raise tax
earnings - while the tariff reductions that followed in 1985 and 1987 were
rather motivated by a policy goal of having a more open economy. Also, as
in the 19761982 period, the real domestic interest rate and the real wage fail
to be significant in explaining any variable. Finally, with respect to the
interaction between real asset prices, apparently only the real stock price
variable seems to be marginally affecting the real price of land.
The variance decomposition exercise confirms most of the information
provided by the F-tests for the blocks of lags. 26 As table 6 indicates, the real
exchange rate accounts for significant portions of (forecast-error variances of)
all remaining variables in the system. Foreign capital inflow shows its

26There is no discussion on the system ordering of variables since, as in the 19761982 period
case, no signs of contemporaneous correlations exist.
134 F.G. Morande!, The dynamics of real asset prices in Chile

strongest contribution when accounting for the forecast error variance of the
real price of land, but also appears influential in the case of housing.
The dynamic nature of the relationships between the real exchange rate
and foreign capital inflows on one side, and real asset prices, on the other,
can be best appreciated by looking at the plotting of impulse response
functions in figs. 8 to 10.
As predicted by our simple model in section 2, the real price of land reacts
strongly after a positive shock to the real exchange rate, going up for eight
months (fig. 8aj.” The real depreciation of the Chilean peso brings higher
real returns to exports, in particular, exports of land-intensive goods like
fresh food. This presses for an increase in the real price of land, as it has
happened during this period. What is also interesting to note is that the
reaction is much quicker now with respect to the real exchange rate than the
reaction of the same price variable with respect to a tariff reform in the
previous period. The response of the real price of land to a shock to foreign
capital inflows (see fig. 8b) is also positive, as during this period it seems that
the effect of capital inflows on foreign credit availability and then on
perceived wealth shows up more strongly than in the 1976-1982 period.
In the case of real stock prices, only the real exchange rate seems to obtain
a significant (and positive) reaction (see fig. 9a). Again this result agrees with
our previous theoretical prediction - a positive b, coefficient in eq. (7) - at
stocks prices are dominated by tradeable industries.28
Real housing prices show to be responsive to the real exchange rate by
decreasing after a positive shock to the latter (fig. 10a). This type of negative
reaction would suggest that in the second sub-period housing and the
importable good tend to be complements on demand, in spite of a non-
significant effect of tariffs. The latter could be due to the volatile nature of
changes in tariffs in this sub-period. On the contrary, a shock to foreign
capital inflows have a positive impact (fig. lob), a reaction that could be
attributed to a greater perceived wealth attached to greater availability of
foreign credit.
Finally, figs. 11 and 12 show the dynamic reactions of foreign capital
inflows and the real exchange rate after shocks in the other variable. As it
could have been expected, a positive shock to foreign capital inflows causes
an appreciation of the real exchange rate: more availability of foreign capital
(and exchange) will allow more spending of both tradeable and non-
tradeable goods, but only non-tradeable prices will go up as tradeable prices
“This is the dynamic interpretation of the model’s result of a positive aS in eq. (6).
‘*We mentioned before that during the 198Os, between 65 and 70% of listed stocks
corresponded to tradeable industries. This percentage was higher than the close to 50% - mostly
import substitution industries - of the early 1970s. Indeed, with an essentially open economy
and with a real exchange rate increasing by around 50% between 1982 and 1987, many
industries that were classified as non-tradeable in the 1970s became involved in either export
activities or substituting imports, now much more expensive.
 F.G. Morandd, The dynamics of real asset prices in Chile 135

RESPONSES OF LAND PRICES TO

SHOCKTOREALEXCHANGERATE SHOCK TO K INFLOWS
19831989 1983 1989

Fig. 9. Responses of stock prices.

RESPONSES OF HOUSING PRlCES TO

SHOCKTOREAL EXCHANGERATE SHOCK TO K INFLOWS

,983 ,989 1983 1989
136 F.G. Mot-and& The dynamics of real asset prices in Chile

RESPONSES OF CAPITAL INFLOWS TO

A SHOCK TO REAL EXCHANGE RATE

1 2 3 4 5 6 7 8 9 I” 11 12 13 14 IS 16 17 I* 192021 zz232.4
PERIODS AFTER SHOCK

Fig. 11. Responses of capital inflows.

RESPONSES OF REAL EXCHANGE RATE TO

A SHOCK TO K INFLOWS

are determined by the nominal exchange rate (which is administered by the

Central Bank) and foreign prices. Meanwhile a real devaluation has some
mixed effects on foreign capital inflows, with some predominance of negative
effects. In any event, both this impulse response exercise as well as variance
decompositions and F-tests for blocks of lags indicate signilicative feedbacks
between these two variables, such that we can rule out exogeneity of them
with respect to each other. This is a striking difference with respect to the
19761982 period, when capital inflows were clearly exogenous.

4. Conclusions

There are significant differences in the behavior of real asset prices between
the period 197&1982 and the period 1983-1989 accruing to the different
roles played by the real exchange rate, tariffs and foreign capital inflows. In
 F.G. Morandi, The dynamics of real asset prices in Chile 137

the first period, when most structural reforms took place, including a trade
reform, tariffs contribute significantly to explain the real price of land, an
asset closely linked to exportable goods. Macroeconomic conditions are
dominated by exogenous foreign capital inflows which not only Granger-
cause the real exchange rate but also greatly determine the evolution of all
real asset prices. In the second period, when foreign capital inflows are much
lower and the nominal exchange rate plays an active role in effecting a real
depreciation, the former variable and the real exchange rate affect each other
and jointly exert great influence on the behavior of real asset prices,
particularly those of assets more closely related to tradeable activity. The
volatility of changes in tariffs, meanwhile, implies that they are not perceived
directly as conforming a counter-structural reform and do not affect the
evolution of real asset prices.
It is clear therefore that real prices of assets do not only obey portfolio
considerations but also some ‘fundamentals’ that are related to structural
reforms and key macroeconomic policies. Indeed, reported results tend to
show that the latter are clearly more important.

Appendix: Data construction

Since most of the series used in the paper were not available in the
frequency required, a methodology for the construction of each series was
developed. The only exception is the Stock Prices Index (IGPA) which is
available on a daily basis; the reported monthly series is the arithmetic
average of daily values of each series.
The only source of continuous information of prices of housing and land is
that of the classified add section of the main Chilean country-wide news-
paper (El Mercurio). The main problem of the data source, apart from being
offer prices and not transaction prices, is that the information does not
reflect only the intrinsic value of the good (houses or land) but also the value
of any other good (or improvement) currently attached to it. In the case of
land, improvements may include plantations, dwellings, machinery and
equipment and livestock. In the case of houses, improvements may include
swimming pools, garages or even the telephone (in Chile, since telephone
connection lags usually last over one year, the availability of a telephone line
is an important component of house prices, as is shown below).
To overcome this heterogeneity problem we developed a methodology in
two steps. First, we defined an ‘ideal’ composition of the good. That is, we
selected a set of characteristics of each good (houses and land) that a priori
was considered to be representative. Second, we ‘cleaned the series from the
value of this attachment, in order to obtain an estimation of the pure price of
the good. The basic assumption is that the price of these attributes contained
in the offer price can be isolated from quoted prices and estimated
138 F.G. MorandP, The dynamics of real asset prices in Chile

econometrically and thus pure value of goods can be computed as the

difference between the observed price and the imputed value of attributes.

Land price index

In order to define the desired ‘land unit’ we focused the search in the more
homogeneous (Central) zone of the country. In adition, we eliminated forest
farms (mainly located on soils with no agricultural alternative use) and farms
smaller than 30 hectares (most of them were subdivided for residential use
and thus changes in prices reflect mostly speculative capital gains).
We collected 360 observations, two observations for each month (from
second and third Sunday’s editions) that matched the above requirements for
the period January 1975 to December 1989, recording the following infor-
mation: Offer Price, Total Area, Artificially Irrigated Area, Location, Exis-
tence of Dwellings (Houses, Milking Plants, etc.), Livestock, Vineyards,
Commercial Orchards and Equipment and Machinery. Since the last five
items can be highly heterogeneous only a dichotomic (zero-one) response
was recorded. Also, irrigated area was eliminated because excessive missing
data.
The above information was corrected to eliminate outliers (122 in total)
which were defined as farm outside two standard deviations of the sample
mean (in terms of area and/or price per hectare). With the remaining sample
we ran a regression with price per hectare as dependent variable and all the
rest of the information as independent variables. As expected, Dwellings,
Livestock and Machinery were not significant while Vineyards and Commer-
cial Orchards were significant at 99%.
The sample was then corrected to discount the value of orchards and
vineyards from all those observations that originally included them. Since in
the final sample there were months in which two observations were available
an average of them was considered. As expected, the series presented high
volatility, so a three-period moving average was used to smooth it.

Housing price index

The principal problem of defining a ‘house unit’ is the existence of both

new and used houses to be sold. The main disadvantages of including new
houses in the sample are: first, that the information on prices is rarely
reported in the newspaper (usually a minimum bound is reported: from $XX
and above), payments and financing conditions make final prices far different
from quoted prices, and location plays a crucial role in setting the price;
second, there are periods in which few new houses are offered mostly because
of stationality and cyclical conditions. Again we focused the search in a
highly homogeneous county of Santiago, whose main characteristics are that
its boundaries are well defined and stable, that little replacement of existing
 F.G. Morandt, The dynamics of real asset prices in Chile 139

houses has been undertaken in the last fifteen years (so the house maintains
its homogeneity).
Again we collected 360 observations for each month that matched the
above requirements, for the period January, 1975 to December, 1989) with
the following information: Selling Price, Number of Rooms, Number of
Baths, Telephone, Separate Living and Dining Room, Close to transpor-
tation or shopping centers, Big gardens, Parking place, Swimming pools.
Since the last six items can be highly heterogeneous only a dichotomic (zero-
one) reponse was recorded. However, the variability of the attributes was
very small (which reflects the homogeneity of the information) so no attempt
of screening the value of attributes by means of inferential regressions was
undertaken. We decided to use the average of the two observations and
eliminated 22 outliers defined as those cases in which the upper price was
20% above the average price or the lower price was 80% of the average price.

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