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UBC Theses and Dissertations

Three essays on expectations and housing price volatility Clayton, Jim


This thesis contains three empirical essays on the economics of house price dynamics. The first essay derives a forward-looking rational expectations house price model and empirically tests its ability to explain short-run fluctuations in real house prices. A novel approach to proxying imputed rents of owner-occupied housing, as a function of housing market fundamentals, is derived and combined with a housing market arbitrage relation to derive a present value model for real house prices. Tests of the rational expectations, nonlinear cross-equation restrictions reject the joint null hypothesis of rational expectations and the asset-based housing price model for quarterly, single-detached house prices in the city of Vancouver, British Columbia, over the 1979-1991 sample period. The model fails to fully capture observed house price dynamics in two real estate booms but tracks real house prices well in less volatile times, suggesting that prices may temporarily deviate from fundamental values in real estate market upswings. The second essay develops and applies a test of the joint null hypothesis of rational expectations, and no risk premium in the Vancouver condominium apartment market. The results show that, on average, ex post house price changes move in the opposite direction than their rational expectation under risk neutrality. This essay also documents the predictability of excess annual condominium returns using lags of annual returns and the rent/price ratio, and quarterly returns with short-term nominal interest rates. It further shows that deviations of house price changes from their (risk neutral) rational expectation are both stationary and related to the stage of the real estate price cycle. The third essay examines whether a time-varying housing market risk premium can explain deviations in house price fluctuations from those predicted by the rational expectations hypothesis under risk neutrality. If homeowners are risk averse and housing price risk is not completely diversifiable then housing market efficiency implies that re turns to housing investment should be positively correlated with a premium for bearing risk. The first part of the essay shows that, in theory, the finding of negative slope co-efficients in tests of unbiased house price expectations under risk neutrality (in chapter 3) is attributable to omitted risk considerations if two conditions are satisfied: (1) the covariance between the risk premium and expected house price appreciation under risk neutrality is negative, and; (2) the variance of the risk premium is considerably larger than the variance of expected appreciation under risk neutrality. The second part of the essay uses a conditional capital asset pricing model to investigate whether predictable returns in the Vancouver housing market are time-varying risk premia. The empirical results are inconclusive.

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