Quantitative modelling of UK housing prices

Abstract

This thesis investigates the value of housing which is a specific group of investment assets and a major component of household wealth for the UK, in particular the primary valuation drivers of the UK housing prices, by using quantitative modelling. Understanding the primary valuation drivers of housing prices will make market participants aware of the size of their risk exposure and can help them to detect early signals of the possibility of investment opportunities. Policy-makers can use information about the underlying valuation drivers of the house prices to stabilize the market. This thesis contributes to literature both methodologically and empirically. This thesis proposes a three-step theoretical framework for studying the drivers of housing prices. The rationale is that people make investment decisions by studying the underlying costs and benefits. Additionally, people respond to expectations under the given behaviour rules, which refer to the institutions in place. There are a series of empirical findings. Firstly, the classical fixed parameter models are poor in terms of robustness, especially the regression coefficient changes in both magnitude and sign over samples. The time varying coefficients indicate the possibility of institutional changes and the changes in expectations. Secondly, the thesis supports the bounded rationality expectation hypothesis implying that the UK housing bubbles reflect people’s biased expectations. The UK house prices were undervalued from 1996Q1 to 2002Q4; and thereafter overvalued. As a proportion, the bubble ranges from -52% to 27.4% in log scale. Thirdly, the thesis empirically supports that the UK housing market experiences both fast-moving and slow-moving institutional changes over previous decades. Fourthly, the thesis does not support the feedback theory. Overall, the three-step theoretical framework is empirically supported. Through a series of institutional changes, people’s biased expectations are playing a far more important role in driving the UK house prices than the fundamentals.