Prosperity or Real Estate Bubble? Exuberance Probability Index of Real Housing Prices in Chile

Byron J Idrovo-Aguirre,Francisco J Lozano,Javier E Contreras-Reyes

doi:10.3390/ijfs9030051

Byron J Idrovo-Aguirre, Francisco J Lozano + Show 1 more

Open Access

https://doi.org/10.3390/ijfs9030051

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Abstract

In this paper, we approached the concept of real estate bubble, analyzing the risk its bursting could generate for the Chilean financial market. Specifically, we analyzed the relationship between real housing prices, the economic activity index, and mortgage interest rates denominated in inflation-linked units from 1994 to 2020. The analysis was based on a second order Markov switching model with the predetermined variables mentioned later, whose parameters were obtained through the expectation–maximization algorithm. Then, we built a probability index as early warning indicator for potential imbalances in the real estate price that could put financial market stability at risk. The indicator is important to evaluate economic policy calibrations in time. A main finding was that the real housing price had a non-linear relationship with economic activity and the mortgage interest rate. Therefore, the evolution of the real estate price has been consistent with fundamental macroeconomic variables, even under a high growth regime, with increases above 12% per year. About 92% of housing price variability derived from changing macrofinancial conditions, suggesting a low margin of speculative behavior.

Highlights

Real estate asset price analysis has been common in the international literature on housing markets and credit, especially after the dramatic effect the financial crisis had on the global economy in terms of productive activity, unemployment, and income (Agnello and Schuknecht 2011; Aguilera Alvial 2020; Balagyozyan et al 2016; Cerutti et al 2017; Gil-Alana et al 2019; Helbling 2005)
Most studies on housing prices are based on the assumption that economic and financial conditions explain a high percentage of price dynamics (Goodhart and Hofmann 2008; Li and Li 2018)
From the results of the switching model for the estimation of the housing price conditional on economic activity index data and mortgage loan interest rates, it followed that 92% of the variability of the price was explained by changes in macrofinancial conditions, suggesting a low margin of speculative behaviors

Summary

Introduction

Real estate asset price analysis has been common in the international literature on housing markets and credit, especially after the dramatic effect the financial crisis had on the global economy in terms of productive activity, unemployment, and income (Agnello and Schuknecht 2011; Aguilera Alvial 2020; Balagyozyan et al 2016; Cerutti et al 2017; Gil-Alana et al 2019; Helbling 2005). Studies that focus on early warning indicators related to real estate activity in Chile did not previously exist Those that mentioned the Chilean housing market were based on linear time series estimates to contrast the economic factors that affect the evolution of housing prices, by estimating Vector Error Correction models From the results of the switching model for the estimation of the housing price conditional on economic activity index data and mortgage loan interest rates, it followed that 92% of the variability of the price was explained by changes in macrofinancial conditions, suggesting a low margin of speculative behaviors In this sense, the episodes of high housing prices responded more to a scenario of prosperity rather than speculative bubbles in the real estate market.

Regime Change Model with Predetermined Variables

Estimation Strategy

Results

Conclusions