Your browser does not support the PubReader view.
Go to this page to see a list of supporting browsers.
Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 31, No. 2, pp.157-193
ISSN: 1225-0279 (Print)
Print publication date 30 May 2018
Received 14 Mar 2018 Revised 04 May 2018 Accepted 04 May 2018

Can Housing Prices be Justified by Economic Fundamentals? Evidence from Regional Housing Markets in Korea

Jan R. Kim ; Sungjin Cho
Jan R. Kim, Primary author, Professor, Department of International Economics and Law, Hankuk University of Foreign Studies, 270 Imun-dong Dongdaemun-gu Seoul, 130-791, South Korea, Tel: +82-2-2173-3225 kjryoul@hufs.ac.kr
Sungjin Cho, Corresponding author, Professor, School of Economics, Seoul National University, Room 208, Building 16, 1 Gwanak-ro, Gwanak-gu, Seoul 08826, South Korea sungcho@snu.ac.kr

JEL Classification: G12, C13, C32

Abstract

In this study, we use a present-value approach to examine the dynamics of six regional housing markets in Korea. The large upswing in the price–rent ratio accompanied by intermittent ups and downs, which are typical features of the Korean housing market since the mid-1980s, is captured by a periodically collapsing bubble incorporated into an otherwise standard present-value model. The movements in the actual price–rent ratio are then decomposed into movements explained by the expectations of housing market fundamentals (i.e., rent growth, risk-free interest rate, and excess returns from housing investment) and the speculative bubble. In all the six regional markets, most of the variations in the fundamental part of the price–rent ratio are explained by the expected risk premium of housing investment and the expected risk-free returns, whereas the expected rent growth account for relatively small fractions of the variations. The bubble has continuously accumulated since the early 2000s in all the six regions and has reached as high as 70% of house price by the end of 2017.

Keywords:

Regional housing markets, Fundamentals, Bubble, Present-value model

Acknowledgments

Research Grant from Hankuk University of Foreign Studies is gratefully acknowledged

Financial support from the Center for Distributive Justice in the Institute of Economic Research of Seoul National University is gratefully acknowledged.

References

  • Balke, N. S. and M. E. Wohar. “Market Fundamentals versus Rational Bubbles in Stock Prices: A Bayesian Perspective.” Journal of Applied Econometrics 24 (No. 1 2009): 35-75. [https://doi.org/10.1002/jae.1025]
  • Bernanke, B. and K. Kuttner. “What explains the Stock Market’s Reaction to Federal Reserve Policy?” Journal of Finance 60 (No.3 2005): 1221-1257. [https://doi.org/10.1111/j.1540-6261.2005.00760.x]
  • van Binsbergen, J. H. and R. S. J. Koijen. “Predictive Regressions: A Present-Value Approach.” Journal of Finance 65 (No. 4 2010): 1439-1471. [https://doi.org/10.1111/j.1540-6261.2010.01575.x]
  • Campbell, J. Y. and J. Ammer. “What moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns.” Journal of Finance 48 (No. 1 1993): 3-48. [https://doi.org/10.1111/j.1540-6261.1993.tb04700.x]
  • Campbell, J. Y. and R. J. Shiller. “The Dividend-price Ratio and Expectations of Future Dividends and Discount Factors.” Review of Financial Studies 1 (No. 3 1988a): 195-228. [https://doi.org/10.1093/rfs/1.3.195]
  • Campbell, J. Y. and R. J. Shiller. “Stock Prices, Earnings, and Expected Dividends.” Journal of Finance 43 (No. 3 1988b): 661-676. [https://doi.org/10.1111/j.1540-6261.1988.tb04598.x]
  • Campbell, S., M. Davis, J. Gallin, and R. Martin. “What moves Housing Markets? A Variance Decomposition of the Rent-price Ratio.” Journal of Urban Economics 66 (No. 2 2009): 90-102. [https://doi.org/10.1016/j.jue.2009.06.002]
  • Cochrane, J. H. “Explaining the Variance of Price-dividend Ratios.” Review of Financial Studies 5 (No. 2 1992): 243-280. [https://doi.org/10.1093/rfs/5.2.243]
  • Cunado, J., L. Gil-Alana, and F. P. de Garcia. “A Test for Rational Bubbles in the NASDAQ Stock Index: A fractionally integrated Approach.” Journal of Banking and Finance 29 (No. 10 2005): 2633-2654. [https://doi.org/10.1016/j.jbankfin.2004.10.003]
  • Engsted, T., T. Q. Pedersen, and C. Tanggaard. “Pitfalls in VAR Based Return Decompositions: A Clarification.” Journal of Banking & Finance 36 (No. 5 2012): 1255-1265. [https://doi.org/10.1016/j.jbankfin.2011.11.004]
  • Gürkaynak, R. S. “Econometric Tests of Asset Price Bubbles: Taking Stock.” Journal of Economic Dynamics and Control 22 (No. 1 2008): 166-186. [https://doi.org/10.1111/j.1467-6419.2007.00530.x]
  • Hwang, M., J. Quigley, and J. Son. “The Dividend Pricing Model: New Evidence from the Korean Housing Market.” Journal of Real Estate Finance and Economics 32 (No. 3 2006): 205-228. [https://doi.org/10.1007/s11146-006-6798-3]
  • Kim, B. and H. Min. “Household Lending, Interest Rates and Housing Price Bubbles in Korea: Regime Switching Model and Kalman Filter Approach.” Economic Modelling 28 (No. 3 2011): 1415-1423. [https://doi.org/10.1016/j.econmod.2011.02.001]
  • Kim, C. J. and C. Nelson. State-space Models with Regime-switching: Classical and Gibbs-sampling Approaches with Applications. Cambridge, U.S.: MIT press, 1999.
  • Kim, K. H. and M. Cho. “Structural Changes, Housing Price Dynamics and Housing Affordability in Korea.” Housing Studies 25 (No. 6 2010): 839-856. [https://doi.org/10.1080/02673037.2010.511163]
  • Kim, J. and S. Cho. “Should the Federal Reserve Have Responded to Asset Prices?” Seoul Journal of Economics 23 (No. 1 2010): 35-55.
  • Kishor, N. and J. Morley. “What Factors drive the Price-rent Ratio for the Housing Market? A modified Present-value Analysis.” Journal of Economic Dynamics and Control 58 (2015): 235-249. [https://doi.org/10.1016/j.jedc.2015.06.006]
  • Lee, Y. and S. Kim. “Are there Speculative Price Bubbles in Gangnam, Seoul Housing Market?” Housing Studies 14 (No. 1 2006): 27-55.
  • Shiller, R. J. and P. Perron. “Testing the Random Walk Hypothesis: Power versus Frequency of Observation.” Economics Letters 18 (No. 4 1985): 381-386. [https://doi.org/10.1016/0165-1765(85)90058-8]
  • Summers, L. H. “Does the Stock Market rationally reflect Fundamental Values?” Journal of Finance 41 (No. 3 1986): 591-601. [https://doi.org/10.1111/j.1540-6261.1986.tb04519.x]
  • Weil, P. “On the Possibility of Price Decreasing Bubbles.” Econometrica 58 (No. 6 1990): 1467-1474. [https://doi.org/10.2307/2938325]
  • Xiao, Q. and D. Park. “Seoul Housing Prices and the Role of Speculation.” Empirical Economics 38 (No. 3 2010): 619-644. [https://doi.org/10.1007/s00181-009-0282-x]