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

- 1.4k Downloads
- 29 Citations

## Abstract

In this paper, we examine changes in the time series properties of three widely used housing market indicators (real house prices, price-to-income ratios, and price-to-rent ratios) for a large set of countries to detect episodes of explosive dynamics. Dating such episodes of exuberance in housing markets provides a timeline as well as empirical content to the narrative connecting housing exuberance to the global 2008 −09 recession. For our empirical analysis, we employ two recursive univariate unit root tests recently developed by Phillips and Yu (International Economic Review 52(1):201–226, 2011) and Phillips et al. (2015). We also propose a novel extension of the test developed by Phillips et al. (2015) to a panel setting in order to exploit the large cross-sectional dimension of our international dataset. Statistically significant periods of exuberance are found in most countries. Moreover, we find strong evidence of the emergence of an unprecedented period of exuberance in the early 2000s that eventually collapsed around 2006 −07, preceding the 2008 −09 global recession. We examine whether macro and financial variables help to predict (in-sample) episodes of exuberance in housing markets. Long-term interest rates, credit growth and global economic conditions are found to be among the best predictors. We conclude that global factors (partly) explain the synchronization of exuberance episodes that we detect in the data in the 2000s.

## Keywords

House prices Mildly explosive time series Sup ADF test Generalized sup ADF test Panel GSADF Probit model## JEL Classification:

C22 G12 R30 R31## Notes

### Acknowledgments

We would like to thank María Teresa Martínez García and Itamar Caspi for providing helpful assistance and suggestions. We acknowledge the support of the Federal Reserve Bank of Dallas. All remaining errors are ours alone. The views expressed in this paper are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Dallas or the Federal Reserve System.

## References

- Adams, Z., & Fuss, R (2010). Macroeconomic determinants of international housing markets.
*Journal of Housing Economics*,*19*(1), 38–50.CrossRefGoogle Scholar - Agnello, L., & Schuknecht, L (2011). Booms and busts in housing markets: determinants and implications.
*Journal of Housing Economics*,*20*(3), 171–190.CrossRefGoogle Scholar - André, C., Gil-Alana, L.A., & Gupta, R (2014). Testing for persistence in housing price-to-income and price-to-rent ratios in 16 OECD countries.
*Applied Economics*,*46*(18), 2127–2138.CrossRefGoogle Scholar - Berkovec, J., Chang, Y., & McManus, D.A (2012). Alternative lending channels and the crisis in U.S. housing markets.
*Real Estate Economics*,*40*(s1), S8–S31.CrossRefGoogle Scholar - Bernanke, B.S. (2005).
*The global saving glut and the U.S. current account deficit. At the Sandridge Lecture*. Richmond, Virginia: Virginia Association of Economists. http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/. - Bhargava, A. (1986). On the theory of testing for unit roots in observed time series.
*Review of Economic Studies*,*53*(3), 369–384.CrossRefGoogle Scholar - Blanchard, O.J. (1979). Speculative bubbles, crashes and rational expectations.
*Economics Letters*,*3*(4), 387–389.CrossRefGoogle Scholar - Blanchard, O.J., & Watson, M.W. (1982). Bubbles, rational expectations, and financial markets. In Wachtel, P. (Ed.)
*Crises in the Economic and Financial Structure*(pp. 295–315). Lexington, MA: Lexington Books.Google Scholar - Busetti, F., & Taylor, A.M.R. (2004). Tests of stationarity against a change in persistence.
*Journal of Econometrics*,*123*, 33–66.CrossRefGoogle Scholar - Campbell, J.Y., & Shiller, R.J. (1987). Cointegration and tests of present value models.
*Journal of Political Economy*,*95*(5), 1062–1088.CrossRefGoogle Scholar - Campbell, J.Y., & Shiller, R.J. (1988). The dividend-price ratio and expectations of future dividends and discount factors.
*Review of Financial Studies*,*1*(3), 195–228.CrossRefGoogle Scholar - Campbell, J.Y., Lo, A.W., & MacKinlay, A.C. (1997).
*The Econometrics of Financial Markets*. Princeton, NJ: Princeton University Press.Google Scholar - Capozza, D.R., Hendershott, P.H., & Mack, C. (2004). An anatomy of price dynamics in illiquid markets: analysis and evidence from local housing markets.
*Real Estate Economics*,*32*(1), 1–32.CrossRefGoogle Scholar - Case, K.E., & Shiller, R.J. (2003). Is there a bubble in the housing market?
*Brookings Papers on Economic Activity*,*34*(2), 299–362.CrossRefGoogle Scholar - Chang, Y. (2004). Bootstrap unit root tests in panels with cross-sectional dependency.
*Journal of Econometrics*,*120*(2), 263–293.CrossRefGoogle Scholar - Chen, S.-S. (2009). Predicting the bear stock market: macroeconomic variables as leading indicators.
*Journal of Banking & Finance*,*33*(2), 211–223.CrossRefGoogle Scholar - Clayton, J. (1996). Rational expectations, market fundamentals and housing price volatility.
*Real Estate Economics*,*24*(4), 441–470.CrossRefGoogle Scholar - Diba, B.T., & Grossman, H.I (1988). Explosive rational bubbles in stock prices?
*American Economic Review*,*78*(3), 520–530.Google Scholar - Engsted, T., Pedersen, T.Q., & Tanggaard, C. (2012). The log-linear return approximation, bubbles, and predictability.
*Journal of Financial and Quantitative Analysis*,*47*(3), 643–665.CrossRefGoogle Scholar - Evans, G.W. (1991). Pitfalls in testing for explosive bubbles in asset prices.
*American Economic Review*,*81*(4), 922–930.Google Scholar - Flood, R.P., & Hodrick, R.J. (1990). On testing for speculative bubbles.
*Journal of Economic Perspectives*,*4*(2), 85–101.CrossRefGoogle Scholar - Girouard, N., Kennedy, M., Van den Noord, P., & André, C. (2006).
*Recent house price developments: the role of fundamentals. OECD Economics Department Working Papers, NO 475*. Paris: OECD Publishing.Google Scholar - Gordon, M.J., & Shapiro, E. (1956). Capital equipment analysis: the required rate of profit.
*Management Science*,*3*(1), 102–110.CrossRefGoogle Scholar - Grossman, V., Mack, A., & Martínez-García, E. (2014). A new database of global economic indicators.
*The Journal of Economic and Social Measurement*,*39*(3), 163–197.Google Scholar - Hiebert, P., & Sydow, M. (2011). What drives returns to euro area housing? evidence from a dynamic dividend-discount model.
*Journal of Urban Economics*,*70*(2–3), 88–98.CrossRefGoogle Scholar - Himmelberg, C., Mayer, C., & Sinai, T. (2005). Assessing high house prices: bubbles, fundamentals and misperceptions.
*Journal of Economic Perspectives*,*19*(4), 67–92.CrossRefGoogle Scholar - Homm, U., & Breitung, J. (2012). Testing for speculative bubbles in stock markets: a comparison of alternative methods.
*Journal of Financial Econometrics*,*10*(1), 198–231.CrossRefGoogle Scholar - Hott, C., & Monnin, P. (2008). Fundamental real estate prices: an empirical estimation with international data.
*Journal of Real Estate Finance and Economics*,*36*(4), 427–450.CrossRefGoogle Scholar - Hwang, M., & Quigley, J.M. (2006). Economic fundamentals in local housing markets: evidence from U.S. metropolitan regions.
*Journal of Regional Science*,*46*(3), 425–453.CrossRefGoogle Scholar - Im, K.S., Pesaran, M.H., & Shin, Y. (2003). Testing for unit roots in heterogeneous panels.
*Journal of Econometrics*,*115*(1), 53–74.CrossRefGoogle Scholar - Kilian, L. (2009). Not all oil price shocks are alike: disentangling demand and supply shocks in the crude oil market.
*American Economic Review*,*99*(3), 1053–1069.CrossRefGoogle Scholar - Kim, J.-Y. (2000). Detection of change in persistence of a linear time series.
*Journal of Econometrics*,*95*(1), 97–116.CrossRefGoogle Scholar - Kim, J.-Y., Belaire-Franch, J., & Badillo Amador, R. (2002). Corrigendum to “detection of change in persistence of a linear time series”.
*Journal of Econometrics*,*109*(2), 389–392.CrossRefGoogle Scholar - Lane, P.R., & Milesi-Ferretti, G.M. (2003). International financial integration.
*IMF Staff Papers*,*50*, 82–113. Special Issue.Google Scholar - Lee, J.H., & Phillips, P.C.B. (2011).
*Asset pricing with financial bubble risk*: Working paper, Yale University.Google Scholar - LeRoy, S.F. (1981). The present-value relation: tests based on implied variance bounds.
*Econometrica*,*49*, 555–577.CrossRefGoogle Scholar - LeRoy, S.F. (2004). Rational exuberance.
*Journal of Economic Literature*,*42*(3), 783–804.CrossRefGoogle Scholar - Mack, A., & Martínez-García, E. (2011). A cross-country quarterly database of real house prices: a methodological note. Globalization and Monetary Policy Institute Working Papers, No. 99. Federal Reserve Bank of Dallas.Google Scholar
- Mack, A., & Martínez-García, E. (2012). Increased real house price volatility signals break from Great Moderation.
*Federal Reserve Bank of Dallas Economic Letter*,*7*(1).Google Scholar - Maddala, G.S., & Wu, S (1999). A comparative study of unit root tests with panel data and a new simple test.
*Oxford Bulletin of Economics and Statistics*,*61*(S1), 631–652.CrossRefGoogle Scholar - Magdalinos, T. (2012). Mildly explosive autoregression under weak and strong dependence.
*Journal of Econometrics*,*169*(2), 179–187.CrossRefGoogle Scholar - Mayer, C. (2011). Housing bubbles: a survey.
*Annual Review of Economics*,*3*, 559–577.CrossRefGoogle Scholar - Mian, A., & Sufi, A (2009). The consequences of mortgage credit expansion: evidence from the U.S. mortgage default crisis.
*The Quarterly Journal of Economics*,*124*(4), 1449–1496.CrossRefGoogle Scholar - Mikhed, V., & Zemcik, P. (2009a). Do house prices reflect fundamentals? aggregate and panel data evidence.
*Journal of Housing Economics*,*18*(2), 140–149.CrossRefGoogle Scholar - Mikhed, V., & Zemcik, P. (2009b). Testing for bubbles in housing markets: a panel data approach.
*Journal of Real Estate Finance and Economics*,*38*(4), 366–386.CrossRefGoogle Scholar - Ng, S., & Perron, P. (1995). Unit root tests in ARMA models with data-dependent methods for the selection of the truncation lag.
*Journal of the American Statistical Association*,*90*(429), 268–281.CrossRefGoogle Scholar - Ng, S., & Perron, P. (2001). Lag length selection and the construction of unit root tests with good size and power.
*Econometrica*,*69*(6), 1519–1554.CrossRefGoogle Scholar - Nyberg, H. (2013). Predicting bear and bull stock markets with dynamic binary time series models.
*Journal of Banking & Finance*,*37*(9), 3351–3363.CrossRefGoogle Scholar - Pavlov, A., & Wachter, S. (2011). Subprime lending and real estate prices.
*Real Estate Economics*,*39*(1), 1–17.CrossRefGoogle Scholar - Phillips, P.C.B., & Magdalinos, T. (2007a). Limit theory for moderate deviations from a unit root.
*Journal of Econometrics*,*136*(1), 115–130.CrossRefGoogle Scholar - Phillips, P.C.B., & Magdalinos, T. (2007b). Limit theory for moderate deviations from a unit root under weak dependence. In Phillips, G.D.A., & Tzavalis, E. (Eds.)
*The Refinement of Econometric Estimation and Test Procedures: Finite Sample and Asymptotic Analysis*(pp. 123–162). Cambridge: Cambridge University Press.Google Scholar - Phillips, P.C.B., & Yu, J. (2011). Dating the timeline of financial bubbles during the subprime crisis.
*Quantitative Economics*,*2*(3), 455–491.CrossRefGoogle Scholar - Phillips, P.C.B., Shi, S.-P., & Yu, J. (2012). Testing for multiple bubbles. Cowles Foundation Discussion Papers, No 1843. Cowles Foundation for Research in Economics: Yale University.Google Scholar
- Phillips, P.C.B., Wu, Y., & Yu, J. (2011). Explosive behavior in the 1990s Nasdaq: when did exuberance escalate asset values?
*International Economic Review*,*52*(1), 201–226.Google Scholar - Phillips, P.C.B., Shi, S.-P., & Yu, J. (2015).
*Testing for multiple bubbles: historical episodes of exuberance and collapse in the S&P 500*: International Economic Review. forthcoming.Google Scholar - Rousová, L., & Van den Noord, P. (2011).
*Predicting peaks and troughs in real house prices. OECD Economics Department Working Papers, No 882*. Paris: OECD Publishing.Google Scholar - Sargent, T.J. (1987).
*Macroeconomic Theory*, 2nd. Boston: Academic Press.Google Scholar - Shiller, R.J. (1981). Do stock prices move too much to be justified by subsequent changes in dividends?
*American Economic Review*,*71*(3), 421–436.Google Scholar - Shiller, R.J. (2015).
*Irrational Exuberance (Revised and Expanded Third Edition)*: Princeton University Press.Google Scholar - West, K.D. (1987). A specification test for speculative bubbles.
*Quarterly Journal of Economics*,*102*(3), 553–580.CrossRefGoogle Scholar - Yiu, M.S., Yu, J., & Jin, L. (2013). Detecting bubbles in Hong Kong residential property market.
*Journal of Asian Economics*,*28*, 115–124.CrossRefGoogle Scholar