An Empirical Analysis of House Price Bubble: Price Bubbles

The contagion of the subprime lending crisis spread from the US market to many other emerging markets such as those in the East Asian nations and Euro Zone countries such as Greece, Italy, Portugal and Ireland. For example, Macquarie Bank in Australia declared losses of 25% for two bond issues, which were invested into senior loans in order to apply leverage. Similarly, the Taiwan Life Insurance Company also announced a loss on securities which were backed by subprime mortgages. Shin Kong Financial Holding Company, which owns the third largest life insurer in Taiwan, was also reported to have invested as much as US$356 million in collateralized debt obligations in subprime mortgages in the US. The Bank of China also reported a significant loss of $9 billion on investments in US subprime securities, which claimed the two hedge funds of the Bear Stearns Company. Financial service

The Chinese housing market also experienced dramatic 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, endangering the Beijing housing market and thus the overall Chinese economy. Hou investigated house prices in Beijing and Shanghai, and reported that speculative behavior dramatically increased house prices in both cities, creating house price bubbles in Beijing and Shanghai.
However, only a few studies have focussed on China’s housing market bubble. For example, Dreger and Zhang identified a housing bubble in China by using ratio analysis. Leung and Wang employed the DiPasquale and Wheaton model to test house price dynamics in China and confirmed the existence of a house price bubble. Similarly, Hou found empirical evidence to support the contention that house price bubbles exist in the Beijing and Shanghai housing markets. However, there does not appear to be a consensus on the existence of a house price bubble in China, with some researchers disputing the existence of one. For example, Hu et al. believed that the main engine of the increase in house prices was driven by economic fundamentals, such as the growth in personal income and variability of interest rates. Shen et al. tested the house price bubble hypothesis in Beijing and Shanghai by comparing market house price with the underlying economic fundamental based house price, finding a house bubble in Shanghai; however, for the Beijing housing market, the authors argued that the increase in house prices was due to fundamentals.
The literature on China’s housing market mostly focuses on a few fundamental variables such as borrower’s income and interest rates. For example, Hu et al. used these variables to model house price dynamics. Similarly, Hou used interest rate, income and rents to capture changes in house prices in China. However, there are few studies which test house prices by including house supply factors, such as construction costs, which impact prices. Construction costs directly affect the total housing supply costs of developers. To this point in time, the literature on the Chinese house market is focussed on the period before 2006. This study extends the data period to 2010.
This paper investigates whether a bubble exists in the Beijing housing market from 1998 to 2010 and relies on economic fundamentals (e.g., interest rates, inflation, cost of supply). We adopt a model developed by Coleman et al. to estimate both the long term trend and short term dynamics of house prices in Beijing.