Testing for bubbles in indirect property price cycles

Abstract

This paper investigates whether the prices of UK equity-traded property stocks over the past fifteen years contain evidence of a speculative bubble. Speculative bubbles are generated when investors include the expectation of the future price in their information set. In the presence of speculative bubbles, positive expected bubble returns will lead to increased demand and will thus force prices to diverge from their fundamental value. The present analysis draws upon the methodologies adopted in various studies examining price bubbles in the general stock market. Fundamental values are generated using two models: the dividend discount and the Gordon growth. Variance bounds tests are then applied to test for bubbles in UK property asset prices. Finally, cointegration analysis is conducted to provide further evidence on the presence of bubbles. Evidence of the existence of bubbles is found but these appear to be transitory and concentrated in the mid-to-late 1990s. Investors in property stocks should be aware that in periods when bubbles are present the market does not move on the basis of the fundamentals and abrupt price corrections can occur.

House Prices, Fundamentals and Bubbles

“…2 2 Momentum behaviour has also been reported for the US securitised real estate market (Chui et al, 2003) and evidence of bubbles in property stocks listed on the UK stock market is found by Brooks et al (2001). …”

A dynamic mathematical test of international property securities bubbles and crashes

“…The first generation bubble tests are volatility tests such as Variance-bound tests (e.g. [20][21][22][23][24]) and Newey-West's Two-Step Test [34]. Basically the specification of these methods is developed to compare the volatility between the assumed fundamental housing price and the actual housing price.…”

Central–local conflict and property cycle: A Chinese style

“…A typical explanation for predicting failure involves imperfect foresight (Akerlof & Shiller, 2009;Case & Shiller, 2004;Clayton, 1998). Irrational expectation, such as myopic anticipation or herd instinct, leads to erratic price fluctuation and helps to explain the boom and bust of property markets (Brooks, Katsaris, Mcgough, & Tsolacos, 2001;Clayton, 1997;Gatzlaff, 1994;Hui & Lui, 2002;Wang, Zhou, Chan, & Chau, 2000); but it cannot distinguish various magnitudes and longitudes of property cycles in different markets. According to Borio and McGuire (2004) and Chen, Kawaguchi, and Patel (2004), cyclical patterns among different countries are fairly similar, but there are always country-specific disturbances, such as those arising from social, political or cultural institutions.…”