No-Bubble Condition: Model-Free Tests in Housing Markets
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
Harvard University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
New York University (NYU)
November 2, 2014
Fama-Miller Working Paper
We test for the existence of classic rational bubbles in housing markets by directly measuring failures of the transversality condition that requires the present value of payments occurring infinitely far in the future to be zero. We study housing markets in the U.K. and Singapore, where residential property ownership takes the form of either leaseholds or freeholds. Leaseholds are finite maturity, pre-paid, and tradable ownership contracts with maturities often exceeding 700 years. Freeholds are infinite maturity ownership contracts. The price difference between leaseholds with extremely long maturities and freeholds reflects the present value of a claim to the freehold after leasehold expiry, and is thus a direct empirical measure of the transversality condition. We estimate this price difference, and find no evidence for classic rational bubbles in housing markets in the U.K. and Singapore, even during periods when a sizeable bubble was regularly thought to be present.
Number of Pages in PDF File: 48
Keywords: Asset Pricing, Real Estate, Rational Bubbles, House Prices, Financial Crisis
JEL Classification: E44, G02, G12, G14, R30
Date posted: May 17, 2014 ; Last revised: February 6, 2015
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