Housing-bubble vulnerability and diversification opportunities during housing boom–bust cycles: evidence from decomposition of asset price returns

This paper examines the implications of housing-bubble vulnerability and time-varying risk management extracted from permanent–transitory ratios of asset price returns, which measure the relative importance of permanent and transitory shocks to asset markets. We extend the unobserved components model, which divides asset price returns into permanent and transitory components, to investigate the interrelations across housing assets, real estate investment trusts (REITs), and stocks in the USA. After 1984, which is the estimated break point in cross-asset interactions, many metropolitan statistical area-level housing markets display vulnerability to housing bubbles due to high permanent–transitory ratios, which suggests weak monetary policy effectiveness in stabilizing the housing boom–bust cycles. Households can diversify long-run risks by establishing stock–housing and REIT–stock portfolios after 1984, but they have fewer diversification opportunities in the post-1984 subperiod than in the pre-1984 subperiod. Copyright Springer-Verlag Berlin Heidelberg 2015