Liquidity and Information Asymmetry in the Real Estate Market

Abstract:     
George Akerlof’s asymmetric information theory explains why lemons are rarely, if at all, transacted. We extend his theory to explain liquidity in the second-hand real estate market. The idea is to decompose real estate asset into two components: Land and the building structure. While sellers may know more about the quality of their structure, information on land, predominantly its locational attributes, is generally much more transparent. Without assuming any credit constraints or loss aversion behaviour, our model shows that 1) real estate liquidity depends on the relative importance of land and building value; 2) there is a positive relationship between real estate prices and trading volume when land value is more volatile than building value; 3) the positive relationship is stronger when most of the property value comes from the structure; and 4) while sales of new development may pull away the demand from second-hand real estate, such a substitution effect is weaker when the land price is high. These four implications have been confirmed with panel data analysis using Hong Kong’s housing transactions over the period 1992-2008 across 50 districts.

Number of Pages in PDF File: 21

Keywords: Information asymmetry, price, volume, land value

JEL Classification: D82, G12

working papers series