Abstract
Under the assumptions of perfect market, house prices should theoretically conform to the present value model (PVM), with expected future rents and discount rates being the two determinants. The objectives of this paper are twofold. First, to evaluate the PVM for Hong Kong private residential housing prices on submarket and territory-wide basis, under the premises of constant and nonconstant homeowner costs of capital. Following Meese and Wallace (1994) approach, we find that the PVM holds in the long run, though temporary deviations are likely. The Campbell and Shiller (1987) approach, on the contrary, generally supports the PVM. This paper would probably be the first examination to that end using Hong Kong empirical data. Second, Ho, Ma and Haurin (2008) find apparent uni-directional Granger-causal relationships (domino effects) along the quality tiers. We will explore not only such effects further on intraarea basis using more recent data, but also the intraclass ripple effects among the three geographical areas (Hong Kong Island, Kowloon, New Territories). We find that domino effects exist only marginally in the New Territories. On the other hand, the ripple effects do exhibit an interesting pattern that the origin of price change tends to shift along an area continuum as the house sizes increase. Lastly, regardless of whether price diffusions can be observed or not, house prices are generally found to be cointegrated in Hong Kong.
Highlights
In finance theory, stock prices equate the discounted present value of expected future dividends to be received
The starting-point for our examination is to use Equation 2 to compute the costs of capital, by imposing a further assumption that the expected rental inflation follows a simple distributed lag of the past actual monthly rental inflation rates measured by the composite CPI for private housing rent from the Census and Statistics Department (CSD) (Dougherty & Van Order, 1982)
The second step is to test for stationarity of all the variables in our two data sets in levels and first differences, by conducting the following four tests: (i) augmented Dickey-Fuller test (ADF), (ii) modified Dickey-Fuller test (DF-GLS), (iii) Phillips-Perron (PP) test, and lastly (iv) KPSS stationary test
Summary
Stock prices equate the discounted present value of expected future dividends to be received. If the PVM is correct, prices and dividends must be cointegrated. In their paper, Campbell and Shiller (1987) attempt to examine the validity of the PVM for stocks, showing that the results depend very sensitively on the discount rate assumed in the test and no conclusive evidence can be drawn. Literatures on the PVM for housing prices and cointegration among prices and/or rents for different countries are huge in quantity. Meese and Wallace (1994) show that the PVM is, in the long run, valid and that house prices, rents, and homeowner costs of capital are cointegrated. A more recent study, Gallin (2008), reveals that house prices and rents are cointegrated (the former tends to correct back to the latter)
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