Lecture 4: Housing bubbles Flashcards
3 ‘pure’ bubble types:
1. Pure ? bubble:
Price is overpriced and will increase for some time ( => too ? to make profits) but will eventually fall.
2. Irrational expectations bubble:
Investors believe t’ ? has ‘fundamentally’ change & ? price patterns are not relevant anymore.
3. Irrational ? bubble:
e.g. Subprime mortgage crisis 2008: Problems with institutions, market regulations, oversight monitoring led to bubble.
3 ‘pure’ bubble types:
1. Pure speculative bubble:
Price is overpriced and will increase for some time ( => too early to make profits) but will eventually fall.
2. Irrational expectations bubble:
Investors believe t’ economy has ‘fundamentally’ change & past price patterns are not relevant anymore.
3. Irrational institutions bubble:
e.g. Subprime mortgage crisis 2008: Problems with institutions, market regulations, oversight monitoring led to bubble.
Create a 'bubble' indicator: S1: Compute a '?' in the time series S2: Find t' ? from t' trend S3: Check if deviation is 'large' (i.e. ? of t' ?? of house price index) S4: Check if prices ? thereafter
Create a 'bubble' indicator: S1: Compute a 'trend' in the time series S2: Find t' deviation from t' trend S3: Check if deviation is 'large' (i.e. half of t' standard deviation of house price index) S4: Check if prices collapse thereafter
Stages of a bubble:
1. ?:
Investors’ ? about a macro shock (e.g. new technology, eco growth)
2. ? :
Prices rise quickly as words spread & more people enter t’ market. Expansion of ?.
3. ?:
Further acceleration of appreciation rate of asset value. Investors trade as they believe prices will continue to rise bec they’ve risen in t’ past.
4. ?:
Some firms fail.
or change in gov policy
those who borrowed are in distress.
5. ?:
When asset values stop rising, they don’t remain ? but start to ? .
Fall in prices => concern th’ prices will fall further => ? & ? => ??.
Stages of a bubble:
1. Displacement:
Investors’ excitement about a macro shock (e.g. new technology, eco growth)
2. Boom:
Prices rise quickly as words spread & more people enter t’ market. Expansion of credit.
3. Euphoria:
Further acceleration of appreciation rate of asset value. Investors trade as they believe prices will continue to rise bec they’ve risen in t’ past.
4. Crisis:
Some firms fail.
or change in gov policy
those who borrowed are in distress.
5. Panic:
When asset values stop rising, they don’t remain static but start to fall.
Fall in prices => concern th’ prices will fall further => panic & selloff => market crash.
Fundamental approach:
House price = ? value + ?
Fundamental approach:
House price = Fundamental value + Bubble
Fundamentals:
Population, Income, Interest rate, rents, land scarcity, construction cost, …
Fundamentals:
Population, Income, Interest rate, rents, land scarcity, construction cost, …
3 types of Fundamental models:
1. Finance based model (aka User cost model):
House price ~= discounted value of its rents.
Equilibrium rent to price ratio:
Rit/Pit = ????
Rit = owner equivalent rent for city i in time t
Pit = purchase price of that home
r_t: interest rate
τ_it: marginal ? rate
( 1 - τ_it) r_t : after tax opportunity cost of capital (adjusted for risk)
m = ? cost
E(%∆Pit) = expected future ? rate of house price
3 types of Fundamental models:
1. Finance based model (aka User cost model):
House price ~= discounted value of its rents.
Equilibrium rent to price ratio:
Rit/Pit = ( 1 - τ_it) r_t + m - E(%∆Pit)
Rit = owner equivalent rent for city i in time t
Pit = purchase price of that home
r_t: interest rate
τ_it: marginal tax rate
( 1 - τ_it) r_t : after tax opportunity cost of capital (adjusted for risk)
m = maintenance cost
E(%∆Pit) = expected future appreciation rate of house price
3 types of Fundamental models:
2. Construction cost model
House price ~= Land value + Structure - Depreciation
- consider ?
3 types of Fundamental models:
2. Construction cost model
House price ~= Land value + Structure - Depreciation
- consider Supply
3 types of Fundamental models:
- Affordability based model
- account for ?
- based on: ‘? households should be able to afford a house.’
- price to ? ratio
e. g. = 13-14: avg households need 13-14 yrs of income to buy a house.
3 types of Fundamental models:
- Affordability based model
- account for Demand
- based on: ‘Average households should be able to afford a house.’
- price to earnings ratio
e. g. = 13-14: avg households need 13-14 yrs of income to buy a house.
Time series approach:
S1. Calculate ? of house prices (i.e. appreciation rates %)
S2. Construct ??: 0 (1st period), 1, 2, etc.
S3. Estimate regression:
Pt = ?
S4. Create a dummy = 1 if u_t > ?
S5. Create a dummy = 1 if price index is ? ? quarters later.
=> Bubble if both dummies = ?.
Time series approach:
S1. Calculate log of house prices (i.e. appreciation rates %)
S2. Construct time index: 0 (1st period), 1, 2, etc.
S3. Estimate regression:
Pt = a + b*time + u_t
S4. Create a dummy = 1 if u_t > (1/n)sd(Pt)
S5. Create a dummy = 1 if price index is lower 3 quarters later.
=> Bubble if both dummies = 1.
Bubbles are more likely to emerge in times of:
Macroeconomic uncertainty and uncertainty
about macroeconomic policies
Structural changes in the economy
Changes in mortgage lending conditions
Changes in the behaviour of market players
Bubbles are more likely to emerge in times of:
Macroeconomic uncertainty and uncertainty
about macroeconomic policies
Structural changes in the economy
Changes in mortgage lending conditions
Changes in the behaviour of market players
Causes of bubble:
- structural changes
- macroeconomic situation
- workings of capital and credit market
- incentives of actors
- beliefs, expectations and plans.
Causes of bubble:
- structural changes
- macroeconomic situation
- workings of capital and credit market
- incentives of actors
- beliefs, expectations and plans.
