Abstract
This paper addresses the interaction between interest rates and the significant increases in both Taiwanese house and stock market prices seen in recent years. Changes in house prices impact banks’ nonperforming loans, whereas changes in interest rates directly influence the ability of individuals and businesses to pay loan interest, accentuating the co-movements between house and stock mar-ket prices. We investigate the nonlinear relations and volatility spillovers among house prices, interest rates and stock market prices using monthly data from January 1985 to March 2009 for Taiwan. We find that the Smooth Transition Vector Error Correction GARCH (STVEC-GARCH) model has the best forecasting ability based on goodness of fit tests while showing a nonlinear and co-integrated relation among the three variables. Specifically, house price leads stock market returns when the interest rate is led by either house price or stock market returns. The volatility of stock market returns has significant impacts on interest rates, implying that borrowers should be aware of stock market fluctuations and thus strengthen their risk management because of unexpected changes.
Highlights
This paper emphasizes the important observation that significant increases in recent house prices and stock market price returns in Taiwan lead to interactive effects among house prices, interest rates, and stock market prices
This paper considers GARCH effects, which are included in the volatility equation for house prices, stock prices, and interest rates
There is a co-integrating effect of house prices, stock market prices and interest rates, suggesting that there are no significant changes in these series in the short-term, and the long-term trend as a result of the effect from other stock markets leads to co-movement among stock prices, interest rates and house prices
Summary
This paper emphasizes the important observation that significant increases in recent house prices and stock market price returns in Taiwan lead to interactive effects among house prices, interest rates, and stock market prices. Applying the Smooth Transition Vector Error Correction GARCH Model (STVEC-GARCH), we empirically explore the nonlinear interrelations and volatility spillovers among house prices, interest rates, and stock market returns in Taiwan using monthly data from January 1985 to March 2009. The researchers showed significant time-varying effects in the conditional covariance between stock returns and direct real estate returns; this indicated that the conditional covariance increases in the boom markets, but becomes weaker in the post-crisis periods. Based on this perspective, the present study applies STVECM-GARCH to model the smooth adjustment and to capture the threshold effect among stock prices, house prices and interest rates in the presence of extreme event occurrences.
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