Episodes of Exuberance in Housing Markets: In Search of the Smoking Gun

Abstract

After a prolonged period characterized by rapid real appreciation in house prices, there is now broad recognition of the severe correction in housing markets that followed as one of the causes of the 2008-09 global recession. We investigate the time series characteristics of three relevant price indicators of the housing market-real house prices, price-to-income, and price-to-rent ratios-for the U.S. and 21 other countries during the period 1975Q1-2013Q2 (see Mack and Martínez-García (2011)) for evidence of explosive behavior as a plausible explanation for the boom and bust. The empirical detection of explosive behavior in house prices provides a precise timeline as well as empirical content to the narrative connecting the evolution of housing markets to the global recession; our rich cross-country dataset o¤ers a novel international perspective. For testing and detection, we adopt a pair of novel techniques based on a right-tail variation of the standard Augmented Dickey-Fuller (ADF ) test-the supremum ADF (SADF ) ) and the generalized SADF (GSADF ) (Phillips et al. (2012) and Phillips et al. (2013))-where the alternative hypothesis is of a mildly explosive process (even periodically collapsing with the GSADF test) behavior within sample. Statistically signi…cant periods of exuberance are found in most countries, with our empirical estimates suggesting an unprecendented synchronization across countries preceeding the global recession. The boom in housing begins during the late 90s in the U.S. spreading to most countries by the early 2000s, until it bursts for most during 2007 08 as the impact on economic activity was being felt. In this regard, our …ndings corroborate the narrative of the 2008-09 global recession. In this paper, we also discuss more generally the use of these procedures to monitor international housing markets and as a warning signal.JEL Classi…cation: C22, G12, R30, R31

Detecting Periods of Exuberance: A Look at the Role of Aggregation with an Application to House Prices

“…The effect, however, is much larger for the SADF test. We also provide evidence that tests based on panel data techniques, namely the panel GSADF test recently proposed by Pavlidis et al (2015), can perform substantially better than univariate tests applied to aggregated series. JEL codes: C22, C12, G12, R30, R31…”

“…We also provide evidence that the panel GSADF recently proposed by Pavlidis et al (2015) is preferable whenever disaggregated data is available.…”

“…4 The ADF approach generalizes the Dickey and Fuller (1979) test by parametrically removing the structural autocorrelation in the time series, but otherwise implements the same testing procedure. et al (2015), together with the novel panel GSADF test of Pavlidis et al (2015). The GSADF test was designed to overcome the SADF's lack of power in identifying multiple episodes of periodically-collapsing mildly explosive behavior within sample.…”

“…Perhaps their most popular application is in real estate markets. 1 Following 1 Conventional testing methods for detecting evidence consistent with the presence of rational bubbles in the time series include unit root and cointegration tests (Diba and Grossman, 1988a;1988b), variance bound tests (LeRoy the housing boom of the early and mid-2000s and its subsequent market collapse leading to the 2008 global recession, there has been a plethora of studies that test for explosive dynamics in real estate prices (e.g., Phillips and Yu, 2011;Pavlidis et al 2015;Engsted et al 2016;Yusupova et al 2016).…”

“…The structure of the remainder of the paper is as follows: Section 2 outlines the SADF test of Phillips and Yu (2011), the GSADF test of Phillips et al (2015), and the panel GSADF test of Pavlidis et al (2015). This section also discusses the potential role of aggregation on the power of the recursive (right-tailed) unit root tests.…”