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Title: No-Bubble Condition: Model-Free Tests in Housing Markets

Author(s): Stefano W Giglio, Matteo Maggiori and Johannes Ströbel

Publication Date: May 2014

Keyword(s): Asset Pricing, financial crisis, house prices, rational bubbles and Real Estate

Programme Area(s): Financial Economics, International Macroeconomics and Public Economics

Abstract: We test for the existence of housing bubbles associated with a failure of the transversality condition that requires the present value of payments occurring infinitely far in the future to be zero. The most prominent such bubble is the classic rational bubble. We study housing markets in the U.K. and Singapore, where residential property ownership takes the form of either leaseholds or freeholds. Leaseholds are finitematurity, pre-paid, and tradable ownership contracts with maturities often exceeding 700 years. Freeholds are infinite-maturity ownership contracts. The price difference between leaseholds with extremely-long maturities and freeholds reflects the present value of a claim to the freehold after leasehold expiry, and is thus a direct empirical measure of the transversality condition. We estimate this price difference, and find no evidence for failures of the transversality condition in housing markets in the U.K. and Singapore, even during periods when a sizeable bubble was regularly thought to be present.

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Bibliographic Reference

Giglio, S, Maggiori, M and Ströbel, J. 2014. 'No-Bubble Condition: Model-Free Tests in Housing Markets'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=9978