Can a stochastic cusp catastrophe model explain housing market crashes?
J. Wang ()
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J. Wang: University of Amsterdam
No 15-12, CeNDEF Working Papers from Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance
Similar to the patterns of stock market prices, housing prices also exhibit temporary bubbles and bursts. One possible explanation for such abrupt changes is the catastrophe model. However, due to the deterministic nature of catastrophe theory, applications to social science are rare. It remains a question whether the catastrophe model can be used to explain and predict the dynamics of housing markets. Our paper fits a stochastic cusp catastrophe model to empirical housing market data in different countries for the first time. Two estimation approaches are discussed â€“ Cobbâ€™s Method and Euler Discretization. The analysis shows that Euler Discretization provides better short-run predictions while Cobbâ€™s better describes the long term invariant density. Moreover, the results using Euler Discretization suggest that the dynamics of housing markets could be explained and predicted by a multiple equilibria cusp catastrophe model. In particular, this paper yields important insights on interest rate policy regarding the stability of economic system.
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