Journal of Economics and Finance

, Volume 36, Issue 1, pp 211–225 | Cite as

The housing bubble in real-time: the end of innocence

Article

Abstract

Market agents suffering through unanticipated boom-bust cycles would find extremely useful analytical techniques capable of serving as an early warning system. Unobserved components models and cointegration analysis are valuable in this respect. The stylized facts from unobserved components models alone do not suffice, but coupled with results from the Johansen cointegration test provided early evidence of the housing bubble and of its denouement. The paper uses real-time data vintages and shows that by 1998 the relationship between the smoothed growth rates of house prices and of per capita income was in uncharted territory. Moreover, the actual growth rates are cointegrated. This is important, as it establishes that any disequilibrium between the two becomes less tenable as its magnitude increases. By 2003, the disequilibrium was spectacular, yet it grew for another 4 years. In effect, we did not have to wait until 2008; the gruesome ending was predictable ex ante. Ironically, the greatest financial delusion of all occurred in an age that revered rationality, market efficiency, and the financial enlightenment of the TBTF actors. The empirical findings of this paper are a major problem for the rational expectations hypothesis and the remnants of the EMH.

Keywords

Cointegration Unobserved Components Rationality Market Efficiency 

JEL Classification

C220 G010 D8 

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Copyright information

© Springer Science+Business Media, LLC 2010

Authors and Affiliations

  1. 1.Finance Department, College of BusinessUniversity of Houston-DowntownHoustonUSA

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