Spatial Dependence in the Residential Canadian Housing Market

Abstract

This paper studies the spatial dependence of residential resale housing returns in ten major Canadian Census Metropolitan areas (or CMAs) from 1992Q4 to 2012Q4 and makes the following methodological contributions. Firstly, in the context of a spatial dynamic panel data model we use grid search to derive the appropriate spatial weight matrix W among different possible specifications. We select the compound W with the minimum root mean squared error formed from geographical distances and the ten CMAs’ gross domestic product. Secondly, contrary to common practice in the literature, we decompose the impacts of explanatory variables into direct and indirect impacts and proceed to derive and plot the impulse response functions of housing returns to external shocks. The empirical results suggest that Canadian residential housing markets exhibit statistically significant spatial dependence and spatial autocorrelation and that both geographical distances and economic closeness are the dominant channels of spatial interaction. Furthermore, the special feature of the Canadian housing market is that the responses to the shocks do not spread widely across regions and that they fade fast over time.