MARKET EFFICIENCY & HOUSEHOLDS' EXPECTATIONS

Abstract

Some critics have charged that the recent price boom in the Singapore private housing market despite a huge potential supply of housing is due to market inefficiencies. Others put the blame on irrational households' expectations. The objectives of this study are twofold. First, it aims to determine empirically if the housing market is efficient. Second, it aims to determine empirically if households are rational. The findings of this study will give an insight of the underlying paradigm in the market. This is useful for policy formulations. Concepts of the efficient markets hypothesis (EMH) and the rational expectations hypothesis (EMH) are defined. In addition, their applications to the housing markets and the limitation encountered in their applications are discussed. The shortcomings of their past applications are highlighted and overcome in this study. An empirical test is conducted to determine if the Singapore private housing market is weak form efficient. A housing returns model is developed and an information set is specified, both of which identify with actual market mechanisms. The empirical result shows that the market is efficient. However this does not explain why prices defies the fundamentals during the recent price boom. It also does not explain why policies formulated based on the efficient markets framework fail to contain price escalation. A possible influence could be households' expectations, which leads to the second empirical test in this study. The expectations prevailing in the market are identified. It is singled out that expected price appreciation affects housing prices. An expectations model is developed and an information set is specified, both of which identify with actual households' behaviour. The empirical result shows that households have irrational expectations. They do not make the best use of all available information in forming expectations. This explains why the price escalation cannot be contained by increasing housing supply. Policy makers must identify households' expectations and account for them in policy formulation to ensure that the desired market equilibrium outcomes are achieved. In summary, this study shows that though the Singapore private housing market is efficient, policies formulated based on an efficient markets framework can be vitiated by irrational households' expectations. To achieve the desired market equilibrium outcomes, policy makers should identify prevailing expectations and account for them in formulating policies.