Speculative Bubble in Asian Real Estate Market - Research Proposal Example

Research Proposal Property Bubble in Asia - Speculative Bubble in Asian Real E Market Summary and of the research Research topic and motivation: House price bubble is viewed to be one of the most important triggers for the start of economic recession and global crisis (Muller, Almy, & Engelschalk, 2010). The most recent mortgage crisis in the United States has added evidence to this point of view (Muller, Almy, & Engelschalk, 2010; Tsai, 2012). While after the global financial crisis in 2008-2009 real estate prices across the world have dropped immediately, soon prices have recovered at alarming rates (Focus: House Price Guessing Games, 2014). Asian real estate market has followed this tendency, with China being one of leaders with the highest pace prices increase. Thus, for example, the prices for real estate in major cities have increased by more than 10 percent in July comparing to the previous year (Gelman, 2013). Shanghai, among other major cities in China, has become a leader in real estate market growth as well as a potential “victim” of the largest property collapse in the world (Ramo, 1998). However, some other emerging markets in Eastern Asian region such as Hong Kong SAR, Singapore, and Korea have illustrated substantial growth of the housing prices and transactions volumes (Imf.org, 2010). This research aims to analyze the speculative bubble in real estate markets in Asia, namely in China, by examining the relationship or common factors if any with the recent U.S. mortgage crisis. The findings of the research could be useful for regulatory bodies responsible for developing policies regulating real estate markets and for further academic researches. 2 A Brief Literature Review 1.2.1 House Price Bubbles There are given many various definitions of the bubble. For example, Kindelberger (1992) believes that it is a sharp rise in price of an asset (cited in Hui et al., 2012). The definition given by Hendershott et al. (2003:993) provides more specific explanation of the bubble, which is “temporary sharp price increase that cannot be plausibly explained by changes in fundamental value drivers” (Hendershott et al. 2003:993). Housing can be used for two major reasons: for residential needs of final consumers and as a tool for investment activity (capital gain after resale or rental revenue) (Tsai, 2012). The real estate market is comprised of a set of separate markets, including the following: owner-occupied housing, rental housing, recreational properties, urban business properties (shops, offices, factories, etc.), and agricultural land (Muller, Almy, & Engelschalk, 2010). There were identified five key reasons of sharp escalation of house prices among which were listed the following three monetary/fiscal policies: low interest rates; extremely favorable tax treatment of owner-occupied housing that is debt-financed; and deregulation of financial market which led to expansion of available credit via introduction and development of new financial products (Muller, Almy, & Engelschalk, 2010). The other two reasons were attributed to the deficit caused by short supply of urban land in attractive areas, and increased purchases of owner-occupied housing for speculative purposes as rental properties (Muller, Almy, & Engelschalk, 2010; Thode, & Culp, 2013). Hendershott et al. (2003) argue against irrational bubbles, suggesting that asset prices deviating from fundamental value do not necessarily imply irrational investors. Ramo (1998) believes that the factors contributing to the bubble of Asian’ real estate markets are the following: financial market liberalization, high savings rates, and directed credit programs. 1.2.4 Regulations of the Real Estate Sector There are suggestions that real estate sector should be regulated by the national governments via implementation of a set of policies. These policies include: microprudential, macroprudential, and monetary policies (Focus: House Price Guessing Games, 2014). Combination of these three categories of policies will allow covering quite a broad range of aspects, including the financial health of individual banks, limitation of individuals’ borrowing capability, and adjustment of real interest rates (Focus: House Price Guessing Games, 2014; Miller, Mohanty, & Zhang, 2009). 1.2.2 Real Estate Market Bubble in Asia As it has been already mentioned prices in Asian real estate market were quickly rebounding after recent global recession (Imf.org, 2010). One of the main drivers of this rebound is referred to the policy measures undertaken by national governments with aim of mitigating the impact of the global financial crisis (Imf.org, 2010). In addition to the fact that Asia historically had the lowest mortgage rates, capital inflows and housing-related tax initiatives introduced by the governments in Korea and China in 2008 have played an important role (Imf.org, 2010). The price-to-rent ratio is the ratio between housing prices and the rental price and is often recognized to be an indicator of potential existence of a bubble in the housing market (Bjørnar 2012). According to the IMF survey (Imf.org, 2010) the price-to-rent index for East Asian countries has elevated since December 2008, while the average price-to-income index has risen very modestly comparing to advanced economies and India. Therefore, elevated price-to-income ratio is important measure for detecting bubbles tendency in real estate markets in China (Bjørnar 2012). A lot of researches and studies related to the real estate bubbles concern specifically the Chinese market. Hatipoglu & Uyar (2012) have suggested that the bubbles originating in one country are more likely to spill over to another country. The researchers have tested such spillover effects based on the example of two countries: the United States and Turkey. The findings have shown that the Turkish asset market was still subject to volatile financial bubbles, stemming from abroad (Hatipoglu & Uyar, 2012). Thus, the concept that bubbles originated in one country affect prices in another country might be applied to the Asian real estate market. As the property sector in China makes up about 12% of the country’s GDP, the consequences of the housing market collapse might have severe effect on many different countries (Chen & Funke 2012). Taking into consideration the role of China in international trade and increased role after accession to WTO, besides the Chinese economy and regional trade partners, the global economy also is more likely to slow down in case of collapse of the real estate market bubble in China. There were carried out many researches investigating the relevance and risks of this bubble collapse in China. In particular, Hui et al. (2012) have focused their investigation on Guangzhou and Shenzhen markets and found that these two markets have been influenced periodically by the explosive bubbles during the period from 2003 to 2006 and from 2009 to 2010. The researchers argued that for the rest of the period, housing markets in these two cities were significantly influenced by various economic events and macroeconomic adjustments (Hui et al., 2012). However, in 2011 there was fixed slight downturn the Chinese real estate market as the government had undertaken several measures and restrictions aiming to cool down house prices to a reasonable level (Chen & Funke, 2012). Research Objectives While there were carried out the studies examining the risks and probability of the real estate market collapse in China and the national government has undertaken some initiatives in order to avoid negative macroeconomic consequences of the housing market collapse in the country (Chen & Funke, 2012), there was limited research with a focus made on the common factor of the real estate market bubble in the USA and China. The research objective is to research for the common factor(s), causing the American mortgage bubble and the Chinese real estate bubble. The hypotheses to be tested in this research are formulated in the following way: Hypothesis H1: real estate property prices in China may be subject to speculative bubbles Hypothesis H2: there are the common factors causing the recent U.S. mortgage bubble and the potential Chinese real estate bubble. The findings of this research may possibly add value to the existing knowledge related to speculative bubbles in Chinese real estate market, and in particular, provide a better understanding of the connections between the factors which led to the recent U.S. mortgage crisis. 2 Research methodology: 1 Methodology In this research, there will be used models motivated by the efficient markets hypothesis where property changes are assumed to be determined by “fundamentals” and “speculative bubbles”. This model allows examining the suggested Hypotheses (Kalra, Mihaljek, & Duenwald, 2000) as it enables comparison to the model of the U.S. housing market based on this model, the asset price in time period t, Pt will be expressed as the sum of its long-run equilibrium price (P t*) and a bubble term (Bt) (Goodman & Thibodeau, 2008). Thus, for testing Chinese real estate market for speculative bubbles, equilibrium prices are determined by “fundamentals” and a bubble term: DRPPIt=DRPPIt* + Bt, where DRPPIt* can be modeled as a function of the growth rate of income, real rental prices, population, construction costs, interest rates’ level and other relevant variables, and Bt- is the error term, which can be further defined as a sum of bubble builder, bubble buster and random variable (Kalra, Mihaljek, & Duenwald, 2000:22). 2 Anticipated results The anticipated results for the research are the following: 1) to analyze how the monetary policies and secondary markets affect the Chinese real estate market; 2) to examine the reasons of high price-to-rent index which is recognized to be one of the indicators of the real estate market bubbles. References Chen, X. & Funke, M. 2012, "Real-time warning signs of emerging and collapsing Chinese house price bubbles", BOFIT Discussion Papers, vol. 2012, no. 27, pp. 4-24. Chen, D., Gan C, Hu B., and Cohen D, 2013, ‘An empirical analysis of house price bubble: a case study of Beijing housing market’. Research in Applied Economics, vol.5, no.1, pp.77-95. FOCUS: House Price Guessing Games 2014, Credit Control, 35, 5, pp. 122-123. Gelman, E 2013, Chinese Still Prefer Property Over Stocks, Bloomberg Businessweek, pp. 52-54. Goodman A, & Thibodeau T, 2008, ‘Where are the speculative bubbles in US housing markets’, Journal of Housing Economics, 17, pp.117-137. Hatipoglu, O, & Uyar, O 2012, Do Bubbles Spill Over? Estimating Financial Bubbles in Emerging Markets, Emerging Markets Finance and Trade, 48, pp. 64-75. Hendershott, P, Hendershott, R, & Ward, C 2003, Corporate Equity and Commercial Property Market Bubbles., Urban Studies, 40, 5-6, pp. 993-1009. Hui, E, Liang, C, Wang, Z, Song, B, & Gu, Q 2012, Real estate bubbles in China: a tale of two cities, Construction Management & Economics, 30, 11, pp. 951-961. Imf.org, 2010. IMF Survey: Asian Real Estate Markets: On Bubble Alert? [online] Available at: http://www.imf.org/external/pubs/ft/survey/so/2010/num060210a.htm Kalra S., Mihaljek D, & Duenwald C, 2000, ‘Property Prices and Speculative Bubbles: Evidence from Hong Kong SAR’, International Monetary Fund, Asia and Pacific Department. Miller, M, Mohanty, I, & Zhang, L 2009, The Illusion of Stability-Low Inflation in a Bubble Economy, Manchester School, 77, pp. 126-149. Muller, A, Almy, R, & Engelschalk, M 2010, Real Estate Bubbles and the Economic Crises: The Role of Credit Standards and the Impact of Tax Policy, Journal of Property Tax Assessment & Administration, 7, 1, pp. 17-40. Ramo, J 1998, ‘The Shanghai Bubble’, Foreign Policy, No. 111, Washington post Newsweek Interactive, LLC pp. 64-75. Thode, S, & Culp, R 2013, How to Avoid Another Housing Bubble and What to Do If It Happens Anyway, Real Estate Finance (Aspen Publishers Inc.), 29, 6, pp. 7-17. Tsai, I 2012, Housing Supply, Demand and Price: Construction Cost, Rental Price and House Price Indices, Asian Economic Journal, 26, 4, pp. 381-396. Read More