Academic journal article Research in Applied Economics

An Empirical Analysis of House Price Bubble: A Case Study of Beijing Housing Market

Academic journal article Research in Applied Economics

An Empirical Analysis of House Price Bubble: A Case Study of Beijing Housing Market

Article excerpt


Increases in house prices can lead to higher house price volatility, a significant determinant of default and the prepayment of housing loans (Miles, 2008). Many researchers believe that significant growth in house price has the potential to generate a house price bubble. The bursting of a house price bubble is likely to endanger the stability of the country's real economy.

China experienced substantial increases in house prices at the end of 1990s. In Beijing, house prices increased dramatically following the liberalization of China's housing market in 1998, and especially so after reforms in 2004. The significant growth of Beijing house prices could have generated a house price bubble, thus endangering the stability of the Beijing housing market and thereby the overall Chinese economy.

This paper investigates whether a bubble existed in the Beijing housing market from 1998 to 2010, using economic fundamental variables such as interest rates, inflation, and cost of supply. Results of the analysis revealed that the Beijing house price index was significantly larger than the equilibrium value, based on the relative economic fundamental variables (income, inflation, interest rate and construction cost) during 2004 to 2007. This result is similar to the findings of Hou (2009), where nearly 75 percent of the changes in Beijing house price were thought to be explained by the economic variables used in the models.

Keywords: house price bubble; interest rates; loans; China

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1. Introduction

The real estate market is described as inefficient and imperfect as compared with other financial markets. This is due to characteristics of the real estate market, which include such influences as fewer transactions, fewer participants, less liquidity and supply rigidities (Kang & Gardner, 1989). These are believed to contribute to the deviation of given real estate market prices from the properties' fundamental values, which leads to the creation of a price bubble or boom in the real estate market (Xia & Tan, 2007). The underlying market characteristics that can impact housing purchase prices are defined as an uncodified set of variables that contribute to determining an asset's price. These can include current values, dividends, and expectations about an asset's value in the future (Garber, 2000). The fundamental variables which often influence house prices are interest rates, income levels and inflation (Shiller, 2007).

The costs of bubbles are expensive, since they can expose a country to bubble-crashes and capital reversals (Caballero & Krishnamurty, 2005). The bursting of a bubble in a housing market can generate a stronger negative impact on the economy compared with a stock market collapse. This is due to high transaction costs, illiquidity and heterogeneity of the housing characteristic (Helbling & Terrones, 2003). The bursting of a house price bubble leads to a slow adjustment process, as house prices tend to revert to their equilibrium price. As a result, inefficient houses prices will prevail in the market for a longer period (Helbling & Terrones, 2003).

As a real estate market plunges, banks and financial institutions lose billions as a result of overexpansion of the market (Kallberg et al., 2002). This loss soon spreads to other parts of the financial sector, resulting in different types of financial problems for institutions and individuals. These can include currency, banking, and stock market crises (Kallberg et al., 2002). For example, Reinhart and Rogoff(cited in Hayford and Malliaris, 2010) found that an asset price bubble is one of the main risks of systemic banking crises, due to credit over-expansion during the asset boom.

The current global financial crisis, where a wide variety of currencies are linked via the mechanisms of foreign exchange and investment, shows how a burst housing bubble can drag down the real economy globally. …

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