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Testing the cointegration of house and stock prices in Finland

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  • Kari Takala

    (Bank of Finland)

  • Pekka Pere

    (The Research Institute of the Finnish Economy)

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    Abstract

    This paper looks at the efficiency of asset markets and pricing rules with regard to house and stock markets in Finland. House and stock prices are found to have unit roots, which is a necessary condition for efficient markets. However, asset prices are not pure random walks, but instead unit root processes. The unit root part is supposed to reflect the changes in fundamentals, and the error component reflects short run deviations from the market equilibrium. Evidence on cointegration between asset prices is found. Based on the hypothesis of cointegration, an error correction model is estimated. Deviations from the long run market equilibrium can be used to improve predictions of stock and house prices, e.g. house price predictions can be improved on average by using lagged changes in the stock index and the equilibrium error as a useful indicator of disequilibrium in the cointegrated markets. The presence of such an error correction term in itself shows that asset markets are not fully efficient. Granger causality between these two aggregate asset prices runs from the volatile stock market to the housing market rather than the opposite way. During the sample period the Finnish money market went through a gradual liberalization process that revealed an imbalance in the asset market caused partly by rationing in the rental housing market. In addition, tax incentives for owner occupied housing and relaxed liquidity constraints significantly increased the demand for houses during the period 1987-89. Real bank lending proved to be a significant predictor for asset prices, especially for real house prices. Error correction models with additional variables due to liquidity constraints, taxation and demand for assets were used to explain the house prices.

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    Bibliographic Info

    Article provided by Finnish Economic Association in its journal Finnish Economic Papers.

    Volume (Year): 4 (1991)
    Issue (Month): 1 (Spring)
    Pages: 33-51

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    Handle: RePEc:fep:journl:v:4:y:1991:i:1:p:33-51

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    References

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    1. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-88, October.
    2. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    3. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    4. Granger, Clive W J, 1986. "Developments in the Study of Cointegrated Economic Variables," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 213-28, August.
    5. Hall, S G, 1986. "An Application of the Granger & Engle Two-Step Estimation Procedure to United Kingdom Aggregate Wage Data," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 229-39, August.
    6. Bossaerts, Peter, 1988. "Common nonstationary components of asset prices," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 347-364.
    7. John Y. Campbell & Robert J. Shiller, 1988. "Interpreting Cointegrated Models," NBER Working Papers 2568, National Bureau of Economic Research, Inc.
    8. Engle, Robert F. & Yoo, Byung Sam, 1987. "Forecasting and testing in co-integrated systems," Journal of Econometrics, Elsevier, vol. 35(1), pages 143-159, May.
    9. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
    10. Michener, Ronald W, 1982. "Variance Bounds in a Simple Model of Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 166-75, February.
    11. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    12. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
    13. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
    14. Blangiewicz, Maria & Charemza, Wojciech W, 1990. "Cointegration in Small Samples: Empirical Percentiles, Drifting Moments and Customized Testing," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(3), pages 303-15, August.
    15. Kari Takala & Matti Tuomala, 1990. "Housing investment in Finland," Finnish Economic Papers, Finnish Economic Association, vol. 3(1), pages 41-53, Spring.
    16. Francis X. Diebold & Marc Nerlove, 1988. "Unit roots in economic time series: a selective survey," Finance and Economics Discussion Series 49, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:
    1. Oikarinen, Elias, 2005. "Is Housing Overvalued in the Helsinki Metropolitan Area?," Discussion Papers 992, The Research Institute of the Finnish Economy.
    2. Berg, Nathan & Gu, Anthony Y. & Lien, Donald, 2007. "Dynamic correlation: A tool hedging house-price risk?," MPRA Paper 26368, University Library of Munich, Germany.
    3. Oikarinen, Elias, 2006. "Price Linkages between Stock, Bond and Housing Markets - Evidence from Finnish Data," Discussion Papers 1004, The Research Institute of the Finnish Economy.
    4. Elias Oikarinen, 2010. "Foreign Ownership of Stocks and Long-run Interdependence Between National Housing and Stock Markets—Evidence from Finnish Data," The Journal of Real Estate Finance and Economics, Springer, vol. 41(4), pages 486-509, November.

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