by elias oikarinen
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ERES Conference 15-18 June, 2011, Eindhoven The Adjustment of Housing Prices Towards the Housing Market No-Arbitrage Relation. By Elias Oikarinen. Background. Housing market no-arbitrage relation gives the asset market equilibrium for housing prices - PowerPoint PPT PresentationTRANSCRIPT
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Turun kauppakorkeakoulu Turku School of Economics
ERES Conference15-18 June, 2011, Eindhoven
The Adjustment of Housing Prices Towards the Housing Market No-Arbitrage Relation
By
Elias Oikarinen
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Turun kauppakorkeakoulu Turku School of Economics
Background
• Housing market no-arbitrage relation gives the asset market equilibrium for housing prices
• In practice, long-lasting deviations from the no-arbitrage relation have been perceived in a number of countries
• The adjustment process towards the no-arbitrage relation is a central question regarding the dynamics and predictability of housing markets
of importance to households, construction companies, investors and to economic policy makers
• Nevertheless, empirical research on the adjustment towards the no-arbitrage relation is limited
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Turun kauppakorkeakoulu Turku School of Economics
Aim of the Study
• To examine empirically the adjustment towards the no-arbitrage relation in the Helsinki Metropolitan Area (HMA) and in the rest of Finland
• To investigate the role of liquidity constraints in the adjustment process
• To estimate the impact of a user cost shock on the free-market housing prices, rents and supply
• To examine whether the dynamics notably differ between the regions
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Turun kauppakorkeakoulu Turku School of Economics
Housing market four-quadrant model (1)
ASSET MARKET: Rent (€/m2) PROPERTY MARKET:Valuation Rent determination
P=R/u
D = S
Price (€/m2) Stock (m2)
S = C/dP=F(C)
ASSET MARKET: Construction (m2) PROPERTY MARKET:Construction Stock adjustment
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Turun kauppakorkeakoulu Turku School of Economics
Asset market equilibrium – the no-arbitrage relation
E(u) = after-tax opportunity cost of capital (%) + depreciation/maintenance (%) – expected appreciation (%)
In the Finnish case, where the imputed rent is not taxed:
• Because of the notable frictions in the housing market, substantial and long-lasting deviations from the asset market equilibrium relation may emerge and the price adjustment towards the relation may be highly sluggish
Ut = Rt – TtitPt – TttPt
E(Ut) = Rt where E(Ut)= Pt E(ut)
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Turun kauppakorkeakoulu Turku School of Economics
Rent (€/m2)
Price (€/m2) Stock (m2)
Construction (m2)
User cost change in the four-quadrant model
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Turun kauppakorkeakoulu Turku School of Economics
• The adjustment dynamics and magnitudes after a user cost shock are of particular interest: via asset price level the shock affects supply, rental price level and the equilibrium price/rent-ratio
• The theory leaves the adjustment speeds and magnitudes open
To get information on the actual adjustment process, rigorous empirical analysis is needed
• Liquidity constraints may influence the adjustment speed
• Adjustment dynamics may differ between regions
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Turun kauppakorkeakoulu Turku School of Economics
Closer look at the impact of a user cost shock
Rent (€/m2)
Price (€/m2) Stock (m2)
Construction (m2)
(e1S)
e1S
e1L
e0
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Turun kauppakorkeakoulu Turku School of Economics
Adjustment paths of the equilibrium price level and the actual price level
Price
time
e1S
e1L
e0
t=0 t=1
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Turun kauppakorkeakoulu Turku School of Economics
Drt = Rt –1Y + 2S
Dst = St –1P + 2CC
Econometric Model
• System of three error-correction models:
Where
(R = 0.72*Y – 2.4*S / 0.67*Y – 2.9*S)
(S = 0.23*P – 0.06*CC / 0.31*P – 0.03*CC)
Exact lag structure and variables not know a priori
Dt = ueqt / (Rt / Pt) -1, where ueq = (Rt – TtitPt – TttPt) / Pt
pt = p – pDpt-1 + ∑piθt-i + pt
rt = r – rDrt-1 + ∑rirt-i + ∑riφt-i + rt
st = s – sDst-i + ∑sist-i + ∑siΩt-i + st
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Turun kauppakorkeakoulu Turku School of Economics
Potential Complication
• Comparability between the housing price and rental price series - different dwellings
• Privately finance flat market price data and square meter prices are used: diminishes the heterogeneity problem
• User cost measurement
• Expected appreciation
• Risk premium
• Liquidity constraints
• Other data complications• E.g. measurement of liquidity constraints
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Turun kauppakorkeakoulu Turku School of Economics
Empirical Findings
• Asset prices appear to adjust towards the no-arbitrage relation significantly but slowly
• No evidence of asymmetric adjustment or liquidity constraints affecting the adjustment speed
• Housing price growth and supply changes are highly predictable
• Also the adjustment speeds of R and S towards the long-term equilbirium relations are low (but significant)
• Adjustment slower in HMA
• Rental price response greater in the rest of Finland
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Turun kauppakorkeakoulu Turku School of Economics
Asset price does most of the adjustment in HMA
The estimated impact of a 10% increase in u on asset price level, rental price level and on housing stock, HMA
-1,60%
-1,40%
-1,20%
-1,00%
-0,80%
-0,60%
-0,40%
-0,20%
0,00%
-0,10-0,09-0,08-0,07-0,06-0,05-0,04-0,03-0,02-0,010,000,010,020,030,040,05
0 10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
160
Quarters from the shock
price
rent
stock
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Turun kauppakorkeakoulu Turku School of Economics
Outside HMA prices adjust less and rents more
The estimated impact of a 10% increase in u on asset price level, rental price level and on housing stock, rest of Finland
-1,80%
-1,60%
-1,40%
-1,20%
-1,00%
-0,80%
-0,60%
-0,40%
-0,20%
0,00%
-0,10
-0,08
-0,06
-0,04
-0,02
0,00
0,02
0,04
0,06
0,08
0,100 10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
160
Quarters from the shock
price
rent
stock
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Turun kauppakorkeakoulu Turku School of Economics
Concluding Remarks
• Theory does not give the adjustment speeds or magnitudes
• Housing prices adjust significantly but slowly towards the asset market equilbirium condition
• It appears that asset prices do the major part of the adjustment after a user cost shock in a highly supply restricted area (HMA)
• The role of rental price adjustment is notably greater in less supply restricted regions (other parts of Finland)
• The impact of changes in the tax code are more complicated: need for further research
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Turun kauppakorkeakoulu Turku School of Economics
Asset market disequilibrium (€/m2, annual level) together with real housing price and rental price indices, HMA
1988 1991 1994 1997 2000 2003 2006 20094.4
4.6
4.8
5.0
5.2
5.4
-12.5
-10.0
-7.5
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
Real rental price index
Real housing price index
Disequilibrium (right scale)
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Turun kauppakorkeakoulu Turku School of Economics
Computation of the user cost
• Maintenance costs from Statistics Finland
• A prediction model for expected appreciation• Prediction for nominal price growth based on an ECM (predictors:
one period lagged values of nominal housing appreciation, nominal aggregate income and of the deviation from a long-run relation between housing prices and aggregate income)
• Constant risk premium at 2% (following Himmelberg et al. 2007)
• Risk-free cost of capital is the average after-tax mortgage rate