Testing the Present Value Model and Domino (Ripple) Effects for Hong Kong Private Residential Housing Prices

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.