Academic journal article The Journal of Real Estate Research

Property Cycles, Speculative Bubbles and the Gross Income Multiplier

Academic journal article The Journal of Real Estate Research

Property Cycles, Speculative Bubbles and the Gross Income Multiplier

Article excerpt

Abstract. We address in this study the question of whether significant price increases occurring during the up-phase of the property cycle can be explained by a speculative bubble. The findings indicate that the Swedish market for income real estate may have been partly driven by a speculative bubble during the 1980's. The conclusion is based on an analysis of panel data where the state of the property cycle is mirrored by the value of the Gross Income Multiplier.


It is unquestionable that major fluctuations in the real estate markets occur, and that some investors profit on them while others lose. Still, many questions are far from fully investigated. Are the observed fluctuations really phases of a cyclical pattern, or are they more like stochastic shocks? Do the market fluctuations have a deterministic component that can be exploited by some market participants, but not all? In other words, are there arbitrage possibilities hidden in the real estate markets that can be revealed by trend chasing? And if this technique is expressible in terms of scientific knowledge, why then do not all market agents avail themselves of this technique and apply it for accumulating wealth? What macro variables in the economy are driving the real estate cycle? These questions are central in the growing literature on real estate cycles. An issue that has arisen in this context is the possible role of speculative bubbles in booming real estate prices.

Some events in economic history, where dramatic market booms have been followed by crashes, have been regarded as speculative bubbles rather than phases of a market cycle. Garber (1990) presents classic examples of market booms connected to the discussion of bubbles. According to Stiglitz (1990), the basic intuition of a bubble, is: "if the reason that the price is high today is only because investors believe that the selling price will be high tomorrow-when "fundamental" factors do not seem to justify such a price-then a bubble exists." However, various formal definitions of a speculative bubble exist. For an extensive theoretical analysis of bubble characteristics see Dixit and Pindyck (1994). Several bubble tests have been suggested in the literature, but according to Flood and Hodrick (1990) no satisfactory proof for the existence of a bubble has yet been presented. However, the empirical literature in this field is growing.

Some studies are found where direct bubble tests are applied to data from booming real estate markets [e.g., Kim and Suh (1993) present a formal statistical test applied to Japanese and Korean data]. There are also studies that indirectly examine the role of speculative bubbles in property markets, by analyzing if fluctuations in property prices seems to be correlated to fluctuations in macroeconomic variables (e.g., Jaffee, 1994). Obviously, there is one particularly crucial question with respect to this approach. Are macroeconomic variables necessarily "fundamental factors" to changes in real estate prices?

Our view is that direct fundamental factors to prices in the real estate market are income, income growth and required rate of return. Other variables, such as macroeconomic variables like interest rate, unemployment and the Gross Domestic Product, etc., indeed affect real estate prices. But they do so indirectly, through their effect on the direct fundamentals. Therefore, it would be possible to have a situation where a large proportion of the observed variation in property prices can be explained by the variation in macro-variables alone, whereas the variation in the property prices cannot equally well be explained in terms of variation in the direct fundamental factors. Thus, the possible existence of speculative bubbles can not be ruled out just because high RZ-values are obtained when regressing various macroeconomic variables on a real estate price variable.

Purpose and Methodology

Our main concern is the question of whether speculative bubbles can in part explain significant price increases occurring during the up-phase of the property cycle. …

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