Detecting Bubbles in the US and UK Real Estate Markets

  • Frank J. FabozziEmail author
  • Iason Kynigakis
  • Ekaterini Panopoulou
  • Radu S. Tunaru


This study considers state of the art subset selection and shrinkage procedures − stepwise regression, ridge regression, lasso, bridge regression and the elastic net along with the commonly employed least squares regression − to detect bubbles in real estate markets. Our analysis of real estate indices representing the commercial, residential and equity real estate sectors in the United States and the United Kingdom finds evidence suggesting the existence of significant periods of overvaluation in residential real estate, as well as economically significant periods of undervaluation in equity real estate markets. The evolution of specific real estate indices in the United States is similar to the evolution of the corresponding indices in the United Kingdom. In order to determine whether the observed deviations of the actual price index from its fundamental value are due to the presence of bubbles, we use two complementary methodologies, the first based on right-side unit root tests for explosive behaviour and the second defined by regime switching models for bubbles. We show that employing an average of all complex models yields more robust forecasting over an 8 years out-of-sample period.


Bubbles identification Fundamental value Real estate index Right-side unit root tests Model uncertainty 

JEL Classification

C32 C53 G17 



  1. Abreu, D., & Brunnermeier, M. K. (2003). Bubbles and crashes. Econometrica, 71, 173–204.CrossRefGoogle Scholar
  2. Astill, S., Harvey, D. I., Leybourne, S. J., & Taylor, A. R. (2016). Tests for an end-of-sample bubble in financial time series. Econometric Reviews, 36, 651–666.CrossRefGoogle Scholar
  3. Belke, A., & Wiedmann, M. (2005). Boom or bubble in the US Real estate market. Intereconomics, 40, 273–284.CrossRefGoogle Scholar
  4. Black, A., Fraser, P., & Hoesli, M. (2006). House prices, fundamentals and bubbles. Journal of Business, Finance and Accounting, 33, 1535–1555.CrossRefGoogle Scholar
  5. Blanchard, O. J. (1979). Speculative bubbles, crashes and rational expectations. Economics Letters, 3, 387–389.CrossRefGoogle Scholar
  6. Blanchard, O. J., & Watson, M. W. (1983). Bubbles, rational expectations and financial markets. NBER Working Paper Series, 945, 1–30.Google Scholar
  7. Brooks, C., & Katsaris, A. (2005a). A three-regime model of speculative behaviour: Modelling the evolution of bubbles in the S&P 500 composite index. Economic Journal, 115, 767–797.CrossRefGoogle Scholar
  8. Brooks, C., & Katsaris, A. (2005b). Trading rules from forecasting the collapse of speculative bubbles for the S&P 500 composite index. Journal of Business, 115, 2003–2036.CrossRefGoogle Scholar
  9. Brooks, C., Katsaris, A., McGough, T., & Tsolacos, S. (2001). Testing for bubbles in indirect property price cycles. Journal of Property Research, 78, 2003–2036.Google Scholar
  10. Buckner, D. (2017), “Taken to the Cleaners”. The Cobden Centre, working paper, September.Google Scholar
  11. Campbell, J. Y., & Shiller, R. J. (1987). Cointegration and tests of present value models. Journal of Political Economy, 95, 1062–1087.CrossRefGoogle Scholar
  12. Campbell, J. Y., Lo, A. W., & MacKinlay, A. C. (1997). The econometrics of financial markets. Princeton: Princeton University Press.Google Scholar
  13. Case, K. E., & Shiller, R. J. (1990). Forecasting prices and excess returns in the housing market. AREUEA Journal, 18, 253–273.CrossRefGoogle Scholar
  14. Case, K. E., & Shiller, R. J. (2003). Is there a bubble in the housing market? Brookings Papers on Economic Activity, 2003(2), 299–362.CrossRefGoogle Scholar
  15. Clark, T. E., & West, K. D. (2007). Approximately normal tests for equal predictive accuracy in nested models. Journal of Econometrics, 138, 291–311.CrossRefGoogle Scholar
  16. Clayton, J., Ling, D. C., & Naranjo, A. (2009). Commercial real estate valuation: Fundamentals versus investor sentiment. Journal Real Estate Finance and Economics, 38, 5–37.CrossRefGoogle Scholar
  17. Cochrane, J. H. (2005). Asset pricing (revised edition). Princeton: Princeton University Press.Google Scholar
  18. De Long, J. B., Shleifer, A., Summers, L., & Waldmann, R. (1990). Noise trader risk in financial markets. Journal of Political Economy, 98, 703–738.CrossRefGoogle Scholar
  19. De Wit, I., & Van Dijk, R. (2003). The global determinants of direct office real estate returns. Journal of Real Estate Finance and Economics, 26, 27–45.CrossRefGoogle Scholar
  20. Diba, B. T., & Grossman, H. I. (1984). Rational bubbles in the price of gold. NBER Working Paper Series, 1300.Google Scholar
  21. Dobson, S. M., & Goddard, J. A. (1992). The determinants of commercial property prices and rents. Bulletin of Economic Research, 44, 301–321.CrossRefGoogle Scholar
  22. Evans, G. W. (1991). Pitfalls in testing for explosive bubbles in asset prices. American Economic Review, 81, 922–930.Google Scholar
  23. Fabozzi, F. J. and Xiao, K. (2019). The timeline estimation of bubbles: The case of real estate. Forthcoming Real Estate Finance.Google Scholar
  24. Fraser, P., Hoesli, M., & McAlevey, L. (2008). A comparative analysis of house prices and bubbles in the UK and New Zealand. Pacific Rim Property Research Journal, 14, 257–278.CrossRefGoogle Scholar
  25. Ghysels, E., Plazzi, A., Valkanov, R., & Torous, W. (2013). Forecasting real estate prices. In G. Elliott & A. Timmermann (Eds.), Handbook of Economic Forecasting (Vol. 2, pp. 509–580) Part A, Chapter 9.Google Scholar
  26. Hamilton, J., & Whiteman, C. (1985). The observable implications of self-fulfilling expectations. Journal of Monetary Economics, 16, 353–373.CrossRefGoogle Scholar
  27. Hastie, T., Tibshirani, R., & Friedman, J. (2009). The elements of statistical learning: Data mining, inference. and prediction (Second ed.). New York: Springer.Google Scholar
  28. Himmelberg, C., Mayer, C., & Sinai, T. (2005). Assessing high house prices: Bubbles, fundamentals, and misperceptions. Journal of Economic Perspectives, 19, 67–92.CrossRefGoogle Scholar
  29. Holly, S., Pesaran, H., & Yamagata, T. (2011). The spatial and temporal diffusion of house prices in the UK. Journal of Urban Economics, 69, 2–23.CrossRefGoogle Scholar
  30. Jarrow, R. and Protter P. (2010), The martingale theory of bubbles: Implications for the valuation of derivatives and detecting bubbles, in Financial Crisis: Debating the Origins, Outcomes, and Lessons of the Greatest Economic Event of Our Lifetime, ed. Arthur Berd, Risk Publications.Google Scholar
  31. Jirasakuldech, B., Campbell, R., & Knight, L. (2006). Are there rational speculative bubbles in REITs? Journal of Real Estate Finance and Economics, 32, 105–107.CrossRefGoogle Scholar
  32. Lai, R. N., & Van Order, R. (2017). US house prices over the last 30 years: Bubbles, regime shifts and market (in)efficiency. Real Estate Economics, 45, 259–300.CrossRefGoogle Scholar
  33. LeRoy, S. F., & Porter, R. D. (1981). The present-value relation: Tests based on implied variance bounds. Econometrica, 49, 555–574.CrossRefGoogle Scholar
  34. Ling, D. C., & Naranjo, A. (1997). Economic risk factors and commercial real estate returns. Journal of Real Estate Finance and Economics, 14, 283–307.CrossRefGoogle Scholar
  35. Ling, D. C., Naranjo, A., & Ryngaert, M. D. (2000). The predictability of equity REIT returns: Time variation and economic significance. Journal of Real Estate Finance and Economics, 20, 117–136.CrossRefGoogle Scholar
  36. Liu, C. H., & Mei, J. (1992). The predictability of returns on equity REITs and their co-movement with other assets. Journal of Real Estate Finance and Economics, 5, 401–418.Google Scholar
  37. MacKinnon, G. H., & Al Zaman, A. (2009). Real estate for the long term: The effect of return predictability on long-horizon allocations. Real Estate Economics, 37, 117–153.Google Scholar
  38. Mei, J., & Liu, C. H. (1994). The predictability of real estate returns and market timing. Journal of Real Estate Finance and Economics, 8, 115–135.Google Scholar
  39. Mei, J., & Saunders, A. (1997). Have US financial institutions’ real estate investments exhibited “trend-chasing” behaviour? Review of Economics and Statistics, 79, 248–259.CrossRefGoogle Scholar
  40. Nneji, O., Brooks, C., & Ward, C. (2013a). Intrinsic and rational speculative bubbles in the US housing market: 1960-2011. Journal of Real Estate Research, 35, 121–151.Google Scholar
  41. Nneji, O., Brooks, C., & Ward, C. (2013b). House price dynamics and their reaction to macroeconomic changes. Economic Modelling, 32, 172–178.CrossRefGoogle Scholar
  42. Payne, J., & Waters, G. (2005). REIT markets: Periodically collapsing negative bubbles? Applied Financial Economic Letters, 1, 65–69.CrossRefGoogle Scholar
  43. Payne, J., & Waters, G. (2007). Have equity REITs experienced periodically collapsing bubbles? Journal of Real Estate Finance and Economics, 34, 207–224.CrossRefGoogle Scholar
  44. Phillips, P. C. B., Wu, Y., & Yu, J. (2011). Explosive behaviour in the 1990 NASDAQ: When did exuberance escalate asset values? International Economic Review, 52, 201–226.CrossRefGoogle Scholar
  45. Phillips, P. C. B., Shi, S., & Yu, J. (2015). Testing for multiple bubbles: Historical episodes of exuberance and collapse in the S&P 500. International Economic Review, 56, 1043–1078.CrossRefGoogle Scholar
  46. Plazzi, A., Torous, W., & Valkanov, R. (2010). Expected returns and expected growth in rents of commercial real estate. Review of Financial Studies, 23, 3469–3519.CrossRefGoogle Scholar
  47. Santos, M., & Woodford, M. (1997). Rational asset pricing bubbles. Econometrica, 65, 19–57.CrossRefGoogle Scholar
  48. Schaller, H., & van Norden, S. (2002). Fads or bubbles? Empirical Economics, 27, 335–362.CrossRefGoogle Scholar
  49. Scheinkman, J., & Xiong, W. (2003). Overconfidence and speculative bubbles. Journal of Political Economy, 111, 1183–1219.CrossRefGoogle Scholar
  50. Shi, S. (2017). Speculative bubbles or market fundamentals? An investigation of US regional housing markets. Economic Modelling, 66, 101–111.CrossRefGoogle Scholar
  51. Shiller, R. J. (1981). Do stock prices move too much to be justified by subsequent changes in dividends? American Economic Review, 71, 421–436.Google Scholar
  52. Tirole, J. (1982). On the possibility of speculation under rational expectations. Econometrica, 50, 1163–1182.CrossRefGoogle Scholar
  53. Tirole, J. (1985). Asset bubbles and overlapping generations. Econometrica, 53, 1071–1100.CrossRefGoogle Scholar
  54. Tunaru, R. (2017). Real-Estate Derivatives. Oxford: Oxford University Press.Google Scholar
  55. van Norden, S. (1996). Regime switching as a test for exchange rate bubbles. Journal of Applied Econometrics, 11, 219–251.CrossRefGoogle Scholar
  56. van Norden, S., & Schaller, H. (1993). The predictability of stock market regime: Evidence from the Toronto stock exchange. Review of Economics and Statistics, 75, 505–510.CrossRefGoogle Scholar
  57. van Norden, S., & Schaller, H. (1999). Speculative behaviour, regime-switching, and stock market crashes. In P. Rothman (Ed.), Nonlinear Time Series Analysis of Economic and Financial Data (pp. 321–356). Norwell: Kluwer Academic Publishers.CrossRefGoogle Scholar
  58. van Norden, S., & Vigfusson, R. (1998). Avoiding the pitfalls: Can regime-switching tests reliably detect bubbles. Studies in Non-Linear Dynamics and Econometrics, 3, 1–22.Google Scholar
  59. Weil, P. (1990). On the possibility of price decreasing bubbles. Econometrica, 58, 1467–1474.CrossRefGoogle Scholar
  60. Zhou, W. -X., & Sornette, D. (2003). 2000-2003 real estate bubble in the UK but not in the USA? Physica A, 329, 249–263.Google Scholar
  61. Zhou, W. -X., & Sornette, D. (2006). Is there a real estate bubble in the US? Physica A, 361, 297–308.Google Scholar

Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  • Frank J. Fabozzi
    • 1
    Email author
  • Iason Kynigakis
    • 2
  • Ekaterini Panopoulou
    • 2
  • Radu S. Tunaru
    • 2
  1. 1.EDHEC, EDHEC Business SchoolNiceFrance
  2. 2.Kent Business SchoolUniversity of KentCanterburyUK

Personalised recommendations