Analysis and determination of house prices

In recent old ages, analysis and finding of house monetary values have been in peculiar involvement non merely to economic experts but besides to econometrists. Changes in monetary values of existent estate and any issues related with the house market have been besides often discussed in the media due to the raising involvement among the general population.

In the beginning of the 1880ss extensive fiscal deregulatings raised the handiness of mortgage finance and stimulated the lodging demand. Banks in the UK started to gain more and more from mortgage loaning. In order to go on the profitable run many Bankss became careless, take downing their standards on house loans. At some point many bank schemes were based on the thought of monolithic loaning without thought of the effects. The temporal economic stableness and house market growing were deceptive and it was a affair of clip before people faced troubles paying back their mortgage payments. The increased figure of the so called “ bad loans ” led the Bankss into problem. They started confronting liquidness jobs and the first large victim was Northern Rock[ 1 ]. UK ‘s biggest supplier of mortgage loans collapsed and shortly after that, the whole economic system was already confronting a recession. It took about three old ages for the UK to go out the recession and the consequence was merely a 0.1 per cent GDP growing for the last one-fourth of 2009. What this paper wants to concentrate on is the house monetary value behavior in the pre-crisis period in the UK.

Many OECD states like UK, USA and Spain experienced a more than 70 per cent addition in house monetary values for the period between 1996 and 2005. By historical criterions, this was a strong public presentation. The existent estate sector played a large and of import function in the recent planetary recession and many concerns were raised about overestimate of house monetary values. In general, houses act as any other good being traded on the market and they should be extremely sensitive to the environing economic environment. Furthermore, the high addition of brooding values in the period of treatment must be supported and explained by economic basicss. A deficiency of econometric grounds for the motions of house monetary values might propose an being of a “ bubble ”[ 2 ]in the lodging market.

In this paper I use monthly time-series informations for a 10 twelvemonth period ramping from 1996 to 2005 to analyze the public presentation of the UK house market. I employ co-integration analysis and Vector error-correction theoretical account attack to measure the long-term equilibrium and the short-term moral force of house monetary value motions in regard to several macroeconomic basicss.

The expounding of this paper is organized as follows. The undermentioned subdivision studies old theoretical and empirical literature on house monetary value behavior. Section 3 derives the theoretical account in the paper and explains the pick of variables. Section 4 applies the Vector-error rectification theoretical account and presents the consequences obtained. Finally, subdivision 5 concludes.

2. Brief economic background theory and literature reappraisal

House monetary value kineticss is a widely discussed subject and there is a assortment of surveies based on it. The figure of academic documents has tripled since the beginning of the rapid addition in house monetary values in industrial states in the late 1890ss. The most popular countries of research are calculating house monetary values, proving for being of bad bubbles and proving for house market efficiency. Harmonizing to the bing literature on the subject, the analysis could be divided into two major attacks. The first attack is more related to macroeconomic theory and attempts to explicate house monetary value behavior with the environing economic environment. The 2nd attack portions thoughts from the fiscal literature by analyzing the price-rent ratio similar to the price-dividend ratio. This attack applies present value theoretical accounts and Campbell, Davis, Gallin, Martin ( 2009 ) suggest that: “ understanding the implicit in structural links between lodging and fiscal markets is likely to be a fruitful country of future research ” . The treatment of the literature will be divided into two parts. Firstly I will discourse briefly literature based on planetary house market behavior and its ‘ relation to the UK. In add-on, the close economic and societal behavior in US and UK tend to reflect the nature of the lodging market in the two states and hence the paper will advert some of the chief part documents on the US belongings market. Finally, the remainder of the subdivision will concentrate merely on the UK house market.

An of import point in a treatment of a house market is the being of a important wealth consequence associated with addition in belongings monetary values. Peoples tend to increase their ingestion when the value of their home appreciates. In the mid nineties the residential belongings in the UK was around 35 per cent of the mean family wealth ( The National Bureau of Economic Research, 2009 ) , which represents that belongingss form large fraction of each family assets. The wealth consequence from lifting house monetary values may be particularly of import in recent decennaries, as institutional inventions ( such as 2nd mortgages in the signifier of secured lines of recognition ) have simplified the chance to pull out hard currency from lodging equity. Furthermore, from the householder point of position it makes sense to utilize a mortgage to fund disbursement because mortgage involvement rates are typically well less than those on recognition cards and unbarred consumer debt. In fact, economic documents like Case and Shiller ( 2001 ) have observed that wealth consequence associated with existent estate are more important that those linked to fiscal plus retentions in most economic systems. All of their empirical consequences back up the decision that changes in house monetary values have a larger and more of import impact than alterations in stock monetary values on family ingestion in US, UK and other well-developed states.

2.1 The planetary and the US house market

Many documents on house monetary value behaviour nowadays more general attacks and seek to explicate the planetary motion of house markets with the aid of panel informations theoretical accounts. McQiunn and O’Reilly ( ) use panel informations analysis and suggest a theoretical theoretical account where the behavior of house monetary values is explained by alterations in existent personal income and involvement rates. They apply panel econometric attacks and singly state attacks for 16 OECD states for the period between 1980 and 2005. Using co-integration analysis their consequences back up the being of a long-term relationship between house monetary values and the cardinal factors. The survey besides found important short-term coefficients of accommodation and reversion to basicss. Adams and Fuss ( 2010 ) besides studied the impact of macroeconomic factors on motion in house monetary values. They used panel of 15 states for a period of 30 old ages and found grounds in many states where in the long-term macroeconomic basicss have important impact on the lodging market. The consequences suggested that 1 % encouragement in economic activity will take to 0.6 % addition in house monetary values, a rise in building costs will ensue a 0.6 % addition in the long-run, and lessening in involvement rate will do a positive alteration of 0.3 % in house monetary values. In add-on, the consequences suggest the being of a instead slow accommodation to equilibrium which may take up to 14 old ages. Beltratti and Morana ( 2009 ) concentrated their analysis on the G-7[ 3 ]country. They besides investigated the connexion between macroeconomic status and alterations in monetary values of belongingss over the period 1980-2007 utilizing factor vector autoregressive theoretical account. Some of their chief decisions derived from the consequences were that supply-side dazes play of import function in house monetary value fluctuations. In add-on, investing demonstrated a stronger influence than end product and ingestion in well-developed states like G-7. This is consistent with the nature of taking economic states where the belongingss are seen more as an investing instead than a topographic point to populate. Furthermore, the paper suggested that US is a taking beginning of planetary house market fluctuations and has a large impact on other economically related states like UK.

Get downing with one of the early surveies on house monetary values in the US lodging market, Poterba ( 1984 ) develops a dynamic theoretical account for house monetary values and economic factors. The consequences obtained from the analysis suggest that the lessening in mortgage rates and the lifting rising prices in the US are the chief ground for the 30 per cent addition in belongingss in the 1970ss. The paper managed to partly supply a model of the equilibrium but issues such as hazard in investing and revenue enhancement intervention were ignored. Case and Shiller ( 1989 ) are some of the innovator works on the subject of house monetary values. Their work was based on time-series regional analysis of the US house market efficiency. The paper suggests that there is a important doggedness in alterations in house monetary values. In add-on, the consequences province that calculating citywide indexes tend to be extremely influenced by noise[ 4 ]. However, the paper fails to mensurate the return on lodging accurately, based on the difference in quality in rent indexes. Furthermore, any efforts to explicate any revenue enhancement consequence runs into troubles and some of their determination could non be applied in several parts in US. Case and Shiller ( 1989 ) has a important part to the early surveies of the subject and has been cited by many future research documents.

In more recent surveies of the existent estate market in US, Mikhed and Zemcik ( 2009 ) look into whether the quickly increasing monetary values of houses prior to 2006 could be justified by several economic factors such as edifice costs, stock market wealth, mortgage rate, personal income, rent and population. The paper employs co-integration analysis for both regional and aggregative informations and based on their consequences they conclude that there was a house monetary value bubble in the US in the period between 1995 and 2006. In add-on, univariate time-series trials for single Metropolitan Statistical Areas point out that the explosion of the bubble which occurred after 2006 has non still set monetary values in line with their basicss and house monetary value might drop even more. The period from the late 1890ss to the beginning of the Global Recession is really sensitive and there are many contradictions among econometric surveies. Several more documents support the being of a bubble. Shiller ( 2005 ) and Gallin ( 2006 ) both came to conclusion utilizing aggregative informations that the fast growing in US house monetary values is non explained by displacements in basicss after 2000. However, McCarthy and Peach ( 2004 ) managed to gauge a theoretical account which consequences came to opposite decisions that there was no bubble in that period in the US and that the alterations in house monetary values reflect motions in nominal mortgage rate and personal income. In add-on, Smith and Smith ( 2006 ) consequences stated that house monetary values were even below basicss, which were derived from house rents where monetary values and rents were taken from a sample of matched single-family places.

As mentioned above in the subdivision, fiscal market theoretical accounts were applied on house monetary values in bing literature. As an illustration Clark ( 1994 ) paper investigates whether motion in house monetary values and rents in the US market are reliable on the advanced behavior of the present value theoretical account. Harmonizing to his consequences in countries where the price-to-rent is high, the future rent growing will be slow. His estimations back up the hypothesis and province that present value theoretical account be given to be of import in house monetary value rating.

Caliman ( 2009 ) discussed the Italian lodging market in the period from 1995 to 2003 and its exposure to flops. The paper used GMM method of appraisal for house monetary values in different states[ 5 ]in Italy. The consequences came to the decision that in Italy house monetary values are mostly justified by economic basicss. Furthermore, harmonizing to the findings the changeless addition in rents and the bead in mortgage rates explain most of the addition in house monetary values. In add-on, the paper provides a prognosis of future motions in monetary values and it suggests that any unexpected beads in monetary values are really improbable. With similar purposes but different attack Merikas, Triantafyllou and Merika ( 2009 ) use co-integration attack for their survey of house monetary values and economic factors in the Grecian house market. They use quarterly informations for the period from 1985 to 2008 and their determination suggest that the chief cardinal factor explicating house monetary value volatility are rising prices, involvement rates, unemployment and stock market. However they mention that a large portion of the displacements in monetary values is caused by: “ behavioural factors built-in in the Grecian society ” .

Spain was another Mediterranean state experienced a important house monetary value grasp in the period get downing from the late 1890ss up to 2003. In their paper Ayuso and Restoy ( 2006 ) they employ GMM and VAR theoretical accounts to mensurate the overestimate of the market in relation to rents. Their chief findings were that the price-to-rent ration in 2003 was above equilibrium in all three states in treatment. In add-on, their consequences showed that UK was approximately 30 % in disequilibrium, Spain around 20 % , and 10 % for the US. They stated that most of the disequilibria in Spain and UK can be explained by the slow accommodation of rents and besides to the deficiency of quality house supply.

2.2 The UK house market

Since the terminal of the war the British lodging market has passed through several long-term rhythms and experienced many structural alterations. Holly and Jones ( ) surveies the behavior of house monetary values in the UK since the 1940s and provides a much longer prospective than other bing literature. The long period in treatment allowed them to capture a assortment of periods with different economic conditions. They studied the effects of personal income, involvement rates, demographic displacements and supply dazes on alterations in house monetary values. The most of import findings of their analysis is that in the long-term the most important driving force of house monetary values in the UK is personal income and through the old ages they appear to travel in line. Their co-integration attack allowed them to capture the accommodation to the long-term equilibrium and the consequences suggested that house monetary values adjust back to equilibrium quicker when they overshoot their cardinal determiners in comparing to when they appear to be below the long-term equilibrium. Some surveies covering with house monetary value motion in the UK during the 1880ss and the beginning of 1890ss manage to supply prognosiss proposing that in the hereafter house monetary values will demo a important and changeless growing. As an illustration, Hasan and Taghavi ( 2002 ) purpose was to analyze the relationship between macroeconomic variables and residential investing over the period 1968-1999. In their paper they use a co-integrated vector autoregressive theoretical account for six variables- end product, mortgage rate, residential investing, money supply, authorities disbursement and monetary value. Harmonizing to their consequences in the long-term financial policy has a modest consequence on residential investing, whereas pecuniary policy appears to hold larger and noticeable impact. The documents findings confirm that the house monetary value rising prices has earnestly increased after the pecuniary deregulatings in the 1980s. In add-on, Brown, Song and McGullivrey ( 1997 ) found that the UK house market experienced several structural alterations and that one of the chief subscribers to the immense instability and sensitiveness was a consequence of the fiscal deregulatings in mortgage loaning market.

As being predicted from prognosiss of old literature house monetary values experienced a important addition get downing from the late 1890ss. At some point the changeless and uninterrupted growing raised inquiries about overestimate among the populace. Many perceivers like the International Monetary Fund ( IMF ) and Organization of Economic Cooperation and Development ( OECD ) were worried about the forming of a bubble in the UK house market. OECD ( 2005 ) suggested that the UK house monetary values were out of line with their basicss for the period 2000-2005. The consequences of the paper coming from econometric theoretical accounts, affordability indexs and asset-pricing attacks showed that there is a presence of overestimate in several states across the universe and one of them is the UK and suggested that any future explosion of bing bubble could hold terrible effects to the economic system. However, some of the restrictions of the analysis were the skip of factors such as weak response on the supply side, demographic alterations, stock market influences and dealing costs. In add-on, the paper uses similar attack for every state, which may take to incorrect consequences as a effect of differences in the nature of each state ‘s house market. Ayuso and Restoy ( 2006 ) is another work which addresses the UK house market as being overvalued in the period 1999-2003. The writers employ an equilibrium plus pricing attack of the price-to-rent ratio and come to decisions that the British lodging market was approximately 30 % above long-term equilibrium by 2003. Zhou and Sornette ( 2003 ) consequences were besides in favor of the being of a bubble in the British lodging market. Although they conclude that low mortgage rates, in-migration and deficiency of land available for edifice in some countries explained the rise in the US lodging market, the writers suggest that an unsustainable bubble was formed in the UK before the downswing of the stock market in 2000 and ended in the terminal of 2003.

In response to the critics and concerns of many planetary establishments besides some academic documents about the overestimate of the house market in the UK, assortment of documents proved them incorrect and presented good and strong statements of what explained the important growing of house monetary values from the period between the late 1890ss and 2003. As an illustration, Cameron ( 2005 ) consequences suggested that most of the addition in homes is explained by the deficiency of lodging stock and besides by demographic factors. The documents consequences lead to decisions that in the period of treatment the available stock for lodging was excessively little and furthermore located in incorrect parts of the state. Cameron, Muellbauer and Murphy ( 2006 ) argue that most of the inquiries about whether or non there was an overestimate in the house market were based on observations of price-to-income ratios or price-to-rent ratios. The paper disputes that such ratios are non really helpful for bubble designation because of import factors such as recognition conditions, lodging supply, demographic and population alterations are non taken into history. In the analysis the writers employ theoretical accounts which capture the consequence of many long-term basicss such as personal income, lodging stock, population, mortgage rates and age composing. In add-on, the writers used regional informations which allows them to place prima parts like London and their “ ripple consequence ”[ 6 ]to other parts across the state.[ 7 ]One of the chief findings of their analysis is that the addition of house monetary values in the period 1997-2003 can be mostly justified by strong growing of personal income, low mortgage rates and low supply of lodging. In add-on, the outperformance of parts such as South and London is explained by population growing caused from immigrants coming to the state and besides strong public presentation of the stock exchange. In their prognosis for 2004-2010 they suggested the possibility of a diminution of future monetary values but concluded that there was no lodging bubble in the British house market for that period and it would be dry if guesss in the promotion turn out to be one of the factors prevented the hazard of explosion of a bubble.

In decision to the treatment of bing literature it could be pointed out that the UK house market is found to be extremely volatile and sensitive to macroeconomic status. It is besides see to portion same tendencies with the US market and besides to be influenced by it. In the period between 1996 and 2005 house monetary values experienced important growing and more general documents utilizing panel informations attacks and besides documents which base their decisions on ratio analysis tend to reason that there is no obvious account of the addition and expressed their concerns of the economic effects of any future explosion of the market. In contrast, documents which deal straight with the UK house market come to opposite decisions and their consequences confirm that alterations in brooding are mostly justified by a careful pick of basicss.

3. Methodology and Datas:

3.1 Methodology:

3.1.1 Explaining the theoretical account

The mark of this paper is to happen any bing long-term relationship between house monetary values and several economic basicss in the United Kingdom for the period from 1996 to 2005 and to measure the short-term kineticss. As mentioned in the subdivision above present value theoretical accounts and ratio analysis, frequently used in fiscal analysis, have been criticised for its public presentation related to the lodging market[ 8 ]and therefore the theoretical account used in the paper falls into the group of surveies[ 9 ], which portions macroeconomic theory and explains house monetary values by the environing economic environment. Since the true house monetary values in the long-term equilibrium are unobserved any effort to gauge these monetary values could be debatable. Therefore, the model of the theoretical account in this paper is based on a Vector autoregressive theoretical account ( VECM ) .

The application of mistake rectification theoretical accounts is considered to be a really powerful rule in applied econometrics. In fact, Alogoskoufis and Smith ( 1991 ) suggested that “ the mistake rectification preparation provides an first-class model within which it is possible to use both the informations information and the information obtainable from economic theory ” . One of the biggest advantages of the VECM is that the theoretical account allows separating long-term and short-term effects. Therefore, the theoretical account will analyse the long-term relationship between house monetary values and macroeconomic basicss and besides capture the short-term fluctuations. The theoretical account in the paper will besides econometrically identify demand and supply factors set uping monetary values.

Let be the existent monetary value, which is equal to the cardinal monetary value, plus any divergence, , where T is the clip period in treatment. Therefore, equation ( 1 ) will be:

As discussed above in the subdivision, the cardinal monetary value, , is unseen. However, if it is assumed that house monetary values reflect the economic environment, they could be expressed as a map of set of macroeconomic factors. Therefore, = , where, , is the set of basicss. Now could be rewritten in equation ( 2 ) .

Equation ( 2 ) is expressed in a specific clip. However, economic theory applies that in the long-term house monetary values will return to their cardinal value. Therefore, the long-term equilibrium is given in equation ( 3 ) .

After placing the long-term status, the mistake rectification theoretical account model can be presented as follows:

, where:

is the alteration in existent monetary values

is the long-term status with regard to

is the lagged alteration of existent monetary value

is the lagged alteration of the map derived from the set of macroeconomic basicss

is an error term, which follows a normal distribution with changeless discrepancy and mean of 0 ( 0, a„¦ ) )

In the instance when the long-term status is non satisfied the accommodation coefficient, , will automatically draw the existent monetary values back to equilibrium.

The Vector mistake rectification theoretical account is similar to the mistake rectification theoretical account with the difference that it is expressed in a matrix signifier. As it will be discussed below, in the existent universe there could be more than one co-integration relationship between the endogenous variables in the VECM.


is a map of the set of macroeconomic basicss deducing the cardinal monetary value ( )

The left-hand side of equation ( ) represents the vector of alterations in house monetary values and economic basicss. The right-hand side includes both the long-term equilibrium and the short-term alterations.

In equation ( ) the first bracket on the right-hand side represents the long-term equilibrium status. In order the long-term status to be, there must be a co-integration relationship between the variables. A set of variables are considered to be co-integrated when the variables themselves are non-stationary but a additive combination between them is stationary[ 10 ]. Any basic OLS appraisal of non-stationary informations could take to a specious arrested development. In add-on, harmonizing to Engle and Granger ( 1987 ) the variables should be integrated in the same order. Therefore, some pretests will be performed in the empirical subdivision in order to show the time-series nature of the information before doing any farther appraisal.

Harmonizing to Granger ‘s representation theorem[ 11 ]presented in Engle and Granger ( 1987 ) , if the coefficient matrix a?? in equation ( )[ 12 ]has a reduced rank R & lt ; K, so there exist k*r matrices I± and I? , each with rank R, such that a??=I±I? ‘ and I? ‘ is stationary. R is a figure of co-integrating dealingss, which is refereed as the co-integration rank, and each column of I? is the co-integration vector. The coefficients I± are known as the accommodation parametric quantities. In order to be able to execute VECM appraisal, at least one co-integration relationship must be. Therefore, the employment of Johansen ‘s co-integration trial method is required to gauge a?? matrix from an unrestricted Vector autoregressive theoretical account ( VAR ) and to prove whether we can reject the limitations implied by the decreased rank of a?? . The intent of the co-integration trial is to prove whether or non the set of endogenous variables is co-integrated and besides to happen how many co-integration relationships there are.

The 2nd bracket of the right-hand side of equation ( ) presents the vector of the first difference of all endogenous variables, where K is the slowdown order based on a pretest performed on the base of an unrestricted Vector autoregressive theoretical account. nowadayss columns of relevant variables which consequence the left-hand side. The last term of the equation is a well behaved mistake[ 13 ].

3.1.2 Choice of variables

As discussed above literature adopts many different macroeconomic basicss in theoretical accounts but still there is no understanding of what could explicate house monetary value volatility in the most precise manner. Some of the most popular economic factors that writers employ in their analysis are Gross Domestic Product ( GDP ) , personal disposable income, population, involvement rates, mortgage rates, stock markets, rising prices, edifice costs, newly-constructed edifices etc. Muellbauer Cameron and Murphy ( 2006 ) suggest that in order to take the most influential macroeconomic factors which explain motions in house monetary values there are many facets that should be taken into consideration. Each state ‘s lodging market is different in nature and should be studied individually in order to acquire an optimum overview. The macroeconomic factors selected for the appraisal of the theoretical account in this analysis are price-to-rent ratio, mortgage rate, stock market and building costs.

The price-to-rent ratio will be used as an option of the house monetary value index. The rent sector of the UK lodging market is comparatively little and besides the informations available for leasing is non fulfilling. However, rents affect the motion of the ratio and in some period restrict the significantly large growing of the house monetary value index.

As mentioned in the literature reappraisal subdivision many academic documents conclude that the fiscal deregulatings of the mortgage rates in the 1980s caused a structural alteration in the house market[ 14 ]. The period 1996-2005 is characterized with important bead in mortgage rates. Since it is truly difficult for families to afford the whole ball amount of money when purchasing a new place, mortgages are one of the chief mechanisms used to buy homes in the UK. Therefore rates should do a large part in explicating the growing of house monetary values. It is expected the mortgage rate to hold a negative consequence on house monetary values in the theoretical account.

One of the chief features of the UK lodging market is that houses are seen more as an investing instead than a shelter. Similar to the US market in UK brooding are more liquid than many other states. In the period between 1996 and 2005 many international common financess, investors and even pension financess invested in UK belongingss. Therefore, motions of house monetary values should non merely reflect but be extremely influenced by the status of the stock exchange.

There are several factors which could stand for a supply-side influence over alterations in house monetary values. The stock of lodging is a normally used factor in empirical analysis but it will non be included in this theoretical account because as mentioned in Cameron ( 2005 ) the lodging on sale in the period of treatment was found to be located in incorrect parts of the state. Therefore for the theoretical account in this paper I will use the cost of building. All types of planetary dazes on primary edifice stuff, addition in rewards in the building sector, land monetary value additions will impact the costs of edifice and therefore building costs should give a good indicant of the supply-side influence on motion in house monetary values. The consequences of the theoretical account are expected to demo a positive relationship between the variables.

3.2 Datas:

The chief beginnings used for the informations are Office of National Statistics, Bank of England, BCIS, Financial Times and Nationwide Anglia Building Society. The computing machine package used for the intent was DataStream 5.0. Table ( 1 ) presents a sum-up of the informations used in this paper.

Price-to-rent ratio: The price-to-rent ratio is constructed with the usage of informations for house monetary value and rent monetary values. The house monetary values are extracted from a seasonally adjusted Nationwide monthly norm house monetary value index and rent monetary values from not-seasonally adjusted CPI index of existent rents for lodging.

Consumer monetary value index: CPI is a non-seasonally adjusted index from Main Economic Indicators, right of first publication OECD. In the analysis it is merely used to lucubrate existent values of the remainder of the variables.

Mortgage rate: Mortgage rate is the Bankss mean terminal of month rate on mortgage loaning.

Cost of building: The cost of building is taken from a non-seasonally adjusted ABI/BCIS house constructing cost index.

FT stock index: Is taken from the non-seasonally adjusted Financial Times All Share Index. The index expresses a transatlantic motions in portion markets by taking into history non merely the UK but besides the US.

Empirical analysis and consequences:

Whenever econometrists deal with time-series informations one of the first belongingss of the informations that must be taken into history is whether or non the information is stationary. A set of informations is found to be stationary when it has a changeless mean and discrepancy[ 15 ]. Additionally, most of economic informations used for empirical analysis is non-stationary and hence all types of processs exist in order to avoid the job of non-stationarity. In fact, an OLS appraisal of a non-stationary information will take to specious arrested development with deceptive high R-square, t-values and low p-values. However, the employment of a Vector error-correction theoretical account VECM does non necessitate the informations to be stationary. In add-on, harmonizing to Engle and Granger ( 1987 ) the information should non be stationary because it will ensue in fiddling result. Nevertheless, in order to gauge a VECM theoretical account the informations should be in the same order of integrating and therefore a pretest for stationarity is still required.

The Augmented Dickey-Fuller trial is employed for the theoretical account in this paper. The trial is and drawn-out version of the Dickey-Fuller trial with the difference that it includes lagged first difference footings among the explanatory variables to guarantee that the remainders will non be correlated. The figure of slowdowns included in the trial is selected by the Akaike Information Criterion which suggests the usage of 12 slowdowns. The large figure of slowdowns needed for the trial is consistent with the high frequence of the information. The trial ‘s two hypotheses are:

: The variable is stationary

: The variable is non-stationary

The void hypothesis of stationarity is rejected when the t-value obtained from the trial is smaller than t-critical value provided in the trial and besides when the p-value is less than 0.05 at a 5 % significance degree and the information is found to be non-stationary. Alternatively, the void hypothesis could non be rejected if the t-value of the trial is bigger than its ‘ critical value and the p-value is more than 0.05 at a 5 % significance degree. In that instance the nothing is accepted and the information is found to be stationary. Table ( 2 ) presents a sum-up of the trial performed for the 4 variables used in the analysis.[ 16 ]

The consequences from the Augmented Dickey-Fuller trial obtained from the values in degrees show that the non-stationary status is satisfied. In add-on, the trial from first difference values suggest that all variables are integrated in order one I ( 1 ) and hence the variables satisfies all conditions of Engle and Granger ( 1987 ) paper mentioned above.

The following measure of the pretest analysis is to find the optimum slowdown length. The mistake rectification theoretical account is considered to be sensitive to order of slowdowns[ 17 ]and therefore a pretest based on an unrestricted Vector autoregressive theoretical account ( VAR ) must be performed in order to choose the best slowdown length the theoretical account requires. This is conditioned to all sets of past variables.

= + + *+ aˆ¦ + * +


rlratio- is the log value of price-to-rent ratio in existent footings

rlmr- is the existent mortgage rate

rlcost- is the log value of cost of building in existent footings

rlft- is the log value of the stock market in existent footings

– is an error term ; 0, a„¦ ) )

The trial for slowdown length choice provides several different consequences from different standards and the two consequences taken into consideration in this analysis are the Akaike Information Criterion ( AIC ) and the Schwarz Bayesian Criteria ( SWB ) . Table ( 3 ) presents a sum-up of the trial.

As it could be observed from the consequences the trial provides two different consequences for lag length choice harmonizing to the Akaike Information Criterion and Schwarz Bayesian Criteria. The AIC trial suggests the appropriate slowdown is found to be seven, nevertheless the SWB trial suggests the pick of two slowdowns. For the theoretical account in this paper the figure of slowdowns selected is based on the consequences from the SWB standards.

The following measure of the analysis, after placing the optimum slowdown length for the theoretical account, is proving for being of co-integration relationship among the variables. The most normally used trial for co-integration is the Engle and Granger ‘s two-step process[ 18 ]. The trial is based on an OLS appraisal from which the remainders are tested for stationarity. However, the Engle-Granger trial is a bi-variate trial and can non place if there is more than one co-integration relationship among a set of variables. Additionally, in a set of variables, there could be co-integration relationships. In the instance of this analysis the theoretical account considers a additive combination of more than two variables and therefore the Johansen Maximum Likelihood process is preferred. The Johansen trial is an appropriate trial for multivariate analysis as it recognizes the being of more than one co-integration relationship among the variables if there are any. The trial is non OLS-based but maximal likeliness based and therefore it requires a large sample. However, the high frequence of the informations will guarantee the trial is every bit appropriate as possible. The Johansen trial produces a matrix vector from an unrestricted Vector autoregressive theoretical account ( VAR ) and trials for rejection of the limitations made by the decreased rank of. The trial produces two different statistics, known as the hint statistics and the maximal eigenvalue statistics. The consequences from both statistics can be used to find the figure of co-integration relationships ( the co-integration rank ) . However, sometimes the statistics show different consequences. The hint statistics is a joint trial, where the void hypothesis is that the figure of co-integrated vectors is less than or equal to ( ) , against the alternate hypothesis that there are more than ( & gt ; ) co-integration vectors. Similar to the hint trial, the Maximum eigenvalue trial individually that there are co-integrating vectors, being the void hypothesis, , against the option, , where there are ( ) co-integrated vectors. Tables ( 4 ) and ( 5 ) below show the consequences from the Johansen co-integration trial for 2 slowdowns and unrestricted co-integration rank.

The void hypotheses of both and from the hint statistics can be rejected at a 5 % significance degree. The hint statistics in both instances is bigger than the critical value and the alternate hypothesis is accepted. In the instance of ra‰¤2 the hint statistics ( 6.975591 ) is a‰¤ ( less than ) the critical value ( 15.49471 ) and the nothing can non be rejected, bespeaking that there are 2 co-integration vectors in the equation. The Maximum Eigenvalue trial points out the same consequence as the Trace Statistics. After the trials were applied we can go on our appraisal of a Vector Error-correction theoretical account ( VECM ) with choice of 2 co-integration equations.

As being proved from the Johansen trial there is no longer a alone co-integration relationship among the variables. Therefore, the bing two co-integration relationships should be interpreted with some cautiousness. In order the Vector auto-correction theoretical account VECM to place the two long-term relationships it is required some limitations to be imposed. Since the analysis is chiefly interested in the effects of the stock exchange, the mortgage rate and the cost of buildings on the price-to-rent ratio, one of the first limitations will be to normalise on the ratio being a dependant variable and the remainder being explanatory variables. In add-on, the explanatory variables show both supply-side and demand-side factors that affect the price-to-rent ratio. Therefore, economic intuition suggests that in order to place the two different co-integration relationships, the supply-side factors should be separated from the demand-side factors. Hence, the first set of limitations imposed to the first co-integration relationship are B ( 1,1 ) =1, B ( 1,4 ) =0[ 19 ]. Additionally, in the 2nd co-integration relationship the set of limitations imposed are B ( 2,1 ) =1, B ( 2,2 ) =0, B ( 2,3 ) =0[ 20 ]. Finally, any limitations imposed on the accommodation coefficient will non be applied in the theoretical account.

Summary tabular array ( ) presents the chief consequences from the VECM theoretical account appraisals.

One of the first nosologies that needs to be performed is whether or non the manually imposed limitations are adhering and besides placing all co-integrating relationships. For that ground, eViews provides a LR trial for adhering limitations and the statistical significance of the limitations is provided by the Chi-square statistics. The consequences show a low Chi-square of 0.225611 and besides a high chance of 0.634798 which suggest that the limitations are found to be statistically important and place both co-integration relationships.

The first decision that could be made from the consequences of the appraisal of the Vector error-correction theoretical account ( VECM ) is that all the coefficients have appropriate marks and moreover are consistent with economic theory. First, the consequence shows a positive long-run relationship between the price-to-rent ratio and the FT stock exchange index. As discussed above in the paper one of the chief premises made for the analysis is the investing position over homes. As UK and besides US, are taking economic powers in the universe many investors put their money in belongings in these states. Therefore, the motion of house monetary values and in the instance of the analysis the price-to-rent ratio should be positively influenced by the status of the stock exchange. Despite the fact that in the period of treatment the stock exchange crashed and experienced a significance bead[ 21 ], the consequences show that there exists a positive long-run relationship between the invariably turning price-to-rent ratio and the FT stock market index.

Second, as expected, the consequences from the theoretical account show that there is a negative long-term relationship between the price-to-rent ratio and the mortgage rate in the period 1996-2005. Since people find it difficult to afford the whole ball amount of money at one time, many families use a mortgage to buy a house. The strength of this peculiar relationship is found to be more and more important particularly after the deregulatings of the fiscal market in the 1980s. In add-on, since the late 1890ss the mortgage rates have been strongly diminishing and hence doing the purchase of a brooding more and more attractive to people.

Finally, the theoretical account estimates a positive mark between the long-term relationship of price-to-rent ratio and the cost of building. In the UK the monetary values of land, rewards and edifice stuff are highly expensive. Furthermore, in the period 1996-2005 builders experienced troubles in edifice in parts with high demand due to the fact that it was either excessively expensive or due to miss of available infinite for new building. In a hazardous concern like building edifice, investors make immense investings and are exposed to a important degree of hazard. Hence, investors will do anything possible in order to maintain their net income borders. For that ground, any addition in building costs strongly boosts the monetary value of houses.

There are some jobs which arise in the theoretical account, specifically in the first co-integration relationship, where the coefficient of the mortgage rate is found to be statistically undistinguished. Despite the right mark, the coefficient is non important, which could raise some inquiries about the explanatory power of the first co-integration. One of the grounds for the insignificance of the coefficient could be the being of overestimate of the lodging market in the period 1999-2003.[ 22 ]In add-on, the macroeconomic factors could neglect to explicate the large addition of house monetary values if there is an bing bubble in the house market.

The Vector error-correction theoretical account ( VECM ) model besides provides an error-correction term which is known as the accommodation coefficient. Therefore, if the price-to-rent ratio perverts from the long-term relationship the mistake rectification will be activated automatically and rectify the divergence. As expected, both adjustment coefficients I± in the two co-integration relationships have a negative mark.