Arbitrage opportunities, efficiency, and the role of risk preferences in the Hong Kong property market

Abstract

This paper aims at investigating how a prospective buyer's optimal home-size purchase can be determined by means of a stochastic-dominance (SD) analysis of historical data of Hong Kong. By means of SD analysis, the paper employs monthly property yields in Hong Kong over a 15-year period to illustrate how buyers of different risk preference may optimize their home-size purchase. Regardless of whether the buyer eschews risk, embraces risk, or indifference to it, in any adjacent pairing of five well-defined housing classes, the smaller class provides the optimal purchase. In addition, risk averters focusing on total yield would prefer to invest in the smallest and second-smallest classes than in the largest class. As the smaller class provides the optimal purchase, the smallest class affords the buyer the optimal purchase over all classes in this important housing market -at least where rental yields are of primary concern. The findings suggest that in the Hong Kong housing market, long-term investors may be better off purchasing smaller homes. For other type of investors, it depends on their risk preference. There is a very small body of empirical literature on housing investment, especially if focuses on the optimal home-size purchase.

Stochastic Dominance and Omega Ratio: Measures to Examine Market Efficiency, Arbitrage Opportunity, and Anomaly

“…In empirical studies, very few studies could discover the existence of any FSD relationship, and it is very important to obtain the FSD relationship (if there is any) because this information is very helpful to investors. For example, the findings from Tsang et al (2016) imply that by shifting investing from the largest class of housing to the smallest class of housing, investors could obtain higher expected utility, as well as higher expected wealth from rental income.…”

“…They do not find any FSD relationship in their study. Tsang et al (2016) extend their work to reexamine the relationship between property size and property investment in the same market and find the FSD relationship in rental yield in any adjacent pairing of the five well-defined housing classes in Hong Kong. In empirical studies, very few studies could discover the existence of any FSD relationship, and it is very important to obtain the FSD relationship (if there is any) because this information is very helpful to investors.…”

“…The housing market in Hong Kong plays a very important role in the Hong Kong economy (Haila (2000)), and Hong Kong is one of the most expensive housing markets in the world in terms of both prices and rents (Tsang et al (2016)). Qiao and Wong (2015) apply SD tests to examine the relationship between property size and property investment in the Hong Kong real estate market.…”

“…They do not find any FSD relationship in their study. Tsang et al (2016) extend their work to reexamine the relationship between property size and property investment in the same market. They suggest to analyze both rental and total yields and find the FSD relationship of rental yield in adjacent pairings of different housing classes in Hong Kong.…”

Management Science, Economics and Finance: A Connection

“…They find evidence that, in general, the yields of smaller property classes stochastically dominate the yields of bigger property classes in the second order, suggesting that risk averters will obtain higher expected utility but not higher expected wealth when buying smaller properties. In addition, Tsang, Wong, and Horowitz show that, regardless of whether the buyers are risk averse or risk seeking; they will not only achieve higher expected utility but also obtain higher expected wealth when buying smaller properties [71].…”