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What Drives Housing Markets: Fundamentals or Bubbles?

Renhe Liu, Eddie Chi-man Hui, Jiaqi Lv () and Yi Chen
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Renhe Liu: South China Agricultural University
Eddie Chi-man Hui: The Hong Kong Polytechnic University
Jiaqi Lv: South China Agricultural University
Yi Chen: Guiyang Central Sub-Branch, The People’s Bank of China

The Journal of Real Estate Finance and Economics, 2017, vol. 55, issue 4, 395-415

Abstract: Abstract This study applies the dynamic Gordon growth model which is in the circumstance of rational bubbles to decompose log price-rent ratio into three parts, i.e., rational bubbles, discounted expected future rent growth rates and discounted expected future returns. The latter two terms represent housing fundamentals. The magnitudes of the components of price-rent ratio’s variance are estimated to distinguish the relative impact of the three parts on housing prices. Using time series data from the housing markets in the four largest cities in China (1991:Q1–2011:Q1 for Shanghai, Guangzhou and Shenzhen; 1993:Q2–2011:Q1 for Beijing), this paper presents a number of empirical findings: (a) the variance of rational bubbles is much larger than the variance of price-rent ratio, and rational bubbles contribute more fluctuations directly to price-rent ratio than the expected returns or the expected rent growth rates do; (b) the covariance between rational bubbles and expected returns or expected rent growth rates is also large; (c) the positive covariance of rational bubbles and expected returns implies that high expected returns coexist with bubbles, which differs from previous findings that lower expected returns drive asset prices; (d) the negative covariance of rational bubbles and expected rent growth rates indicates that the larger the bubbles are, the lower the expected rent growth rates are; (e) the positive covariance of expected returns and expected rent growth rates reveals under-reaction of the housing markets to rents.

Keywords: Price-rent ratio; Variance decomposition; Rational bubbles; Return (search for similar items in EconPapers)
Date: 2017
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