Abstract
This article aims to investigate the relationship between inbound tourism and housing market along with the recent boom in Icelandic real estate sector, in which both house and rental prices have been rising dramatically. To this end, we construct a small open economy dynamic stochastic general equilibrium model enclosing a tourism sector and a housing market with owner-occupied and rental sections. The simulation results unveil a transmission channel that indicates the higher inbound tourism demand raises both house prices and rental prices. Variance decomposition and historical decomposition show that both inbound tourism demand shock and manufacturing technology shock are the key driving forces of the fluctuations of Icelandic house prices, consumption, and investment, whereas housing preference shock plays the most important role in determining the volatility of rental prices. The policy implications indicate that any shocks to tourism could easily spillover to housing market dynamics and aggregate fluctuations.