Integration and contagion in US housing markets

Cotter, John and Gabriel, Stuart and Roll, Richard (2011): Integration and contagion in US housing markets.

Abstract

This paper explores integration and contagion among US metropolitan housing markets. The analysis applies Federal Housing Finance Agency (FHFA) house price repeat sales indexes from 384 metropolitan areas to estimate a multi-factor model of U.S. housing market integration. It then identifies statistical jumps in metropolitan house price returns as well as MSA contemporaneous and lagged jump correlations. Finally, the paper evaluates contagion in housing markets via parametric assessment of MSA house price spatial dynamics.

A R-squared measure reveals an upward trend in MSA housing market integration over the 2000s to approximately .83 in 2010. Among California MSAs, the trend was especially pronounced, as average integration increased from about .55 in 1997 to close to .95 in 2008! The 2000s bubble period similarly was characterized by elevated incidence of statistical jumps in housing returns. Again, jump incidence and MSA jump correlations were especially high in California. Analysis of contagion among California markets indicates that house price returns in San Francisco often led those of surrounding communities; in contrast, southern California MSA house price returns appeared to move largely in lock step.

The high levels of housing market integration evidenced in the analysis suggest limited investor opportunity to diversify away MSA-specific housing risk. Further, results suggest that macro and policy shocks propagate through a large number of MSA housing markets. Research findings are relevant to all market participants, including institutional investors in MBS as well as those who regulate housing, the housing GSEs, mortgage lenders, and related financial institutions.

• Item Type: MPRA Paper
• Language: English
• Keywords: integration; correlation; contagion; house price returns
• Subjects: G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G10 - General

References

Barndorff-Nielsen, O., and Shephard, N. 2006. Econometrics of testing for jumps in financial economics using bipower variation. Journal of Financial Econometrics 4, 1-30.

Bekaert, G., and Harvey, C., 1995. “Time-Varying World Market Integration”, Journal of Finance 50, 403-444.

Bekaert, G., Harvey, C., Lundblad, C., and Siegel, S., 2008. What Segments Equity Markets? AFA 2009 Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1108156.

Case, K., Cotter, J., and Gabriel, S., Housing Risk and Return: Evidence from a Housing Asset Pricing Model, Journal of Portfolio Management, forthcoming, 2011.

Carrieri, F., Errunza, V., and Hogan, K., 2007, Characterizing World Market Integration Through Time. Journal of Financial and Quantitative Analysis, 42, 915-940.

Chambet, A., and Gibson, R., 2008, Financial Integration, Economic Instability, and Trade Structure in Emerging Markets, Journal of International Money and Finance 27, 654-675.

Hardouvelis, G., Malliaropoulos, D., and Priestley, R., 2006. EMU and European stock market integrations Journal of Business 79, 369-392.

Henderson, V., Economic Theory and the Cities, Academic Press, New York, 1977.

Jacod, J., and Todorov, V. 2009. Testing for common arrivals of jumps for discretely observed multidimensional processes. The Annals of Statistics 37, 1792-1838.

Jiang, G., and Oomen, R. 2008. Testing for jumps when asset prices are observed with noise – a “swap variance” approach. Journal of Econometrics 144, 352-370.

King, M. A., and S. Wadhwani, 1990, Transmission of volatility between stock markets, Review of Financial Studies 3, 5-33.

Lee, S., and Mykland, P., 2008. Jumps in financial markets: A new nonparametric test and jump dynamics, Review of Financial Studies 21, 2535-2563.

Longin, F., Solnik, B., 1995. Is the correlation in international equity returns constant: 1960-1990? Journal of International Money and Finance 14, 3-26. Longin, F., and Solnik, B., 2001, Extreme correlation of international equity markets, Journal of Finance, 56: 649-676.

Pukthuanthong-Le, K., and Roll, R. Global Market Integration: An Alternative Measure and Its Application, Journal of Financial Economics, 2009, 94(2), 214-232.

Pukthuanthong-Le, K., and Roll, R., Internationally Correlated Jumps, Working Papers in Finance, UCLA Anderson School of Management, July 2010.

Schotman, P., and Zalewska, A., 2006, Non-synchronous trading and testing for market integration in Central European emerging markets, Journal of Empirical Finance 13, 462-494.