Political Uncertainty and Asset Valuation: Housing Prices in Hong Kong

Abstract

We empirically analyze the pricing of political uncertainty in a long-term asset market, guided by a theoretical model of housing assets subject to contract extension in the remote future. To identify exposure to political uncertainty, we exploit a unique variation around land lease extension protection beyond 2047 in Hong Kong's housing market due to the historical arrangements under the “One Country, Two Systems” design. We find political uncertainty is priced, as predicted by theory, in that relative to properties that have been promised an extension protection, those with legally unprotected leases granted by the current Hong Kong government are sold at a substantial discount of around 8%. Similar contracts issued during the colonial era suffer an additional discount of about 8% due to their reneging risk. Our calibrated model implies that to extend their leases homeowners expect about 25% of penalty on ground rent after 2047. The discount is higher when people's confidence declines and where residents feel more uncertain of the city's future.