EMPIRICAL ANALYSIS OF BUBBLE EXISTENCE IN THE RETAIL PROPERTY SECTOR

Abstract

This study investigates the Singapore retail property sector for the presence of asset bubble formation between 2003Q1 and 2013Q2. The key research objective of this paper is to assess the existence of an asset bubble in the sector through empirical techniques. The second objective involves generating the fundamental values of the retail property sector and quantifying the asset bubble should one be detected. Based on the literature, a present value model (Wang, 2000) and a time-varying present value model (Black, Fraser & Hoesli, 2006) were employed in empirically ascertaining the existence of an asset bubble. At the 5% significance level, the stationarity analysis and co-integration test applied in the present value model detected asset bubble formation. This was corroborated by the findings of the time-varying present value model. The Johansen co-integration test showed that a long run equilibrium relationship exists among the three variables used in the vector autoregressive (VAR) model, namely price-rent ratio, real rental growth, and the variance of returns. By restricting the VAR model’s coefficients, the standard Wald test finds that at the 5% significance level, real prices and fundamental values deviate sufficiently to constitute an asset bubble. With both models concurring that there is asset bubble formation in the retail property sector within the study period, the fundamental values of retail property are dynamically forecast using the three-variable VAR model employed in Black, Fraser and Hoesli (2006)’s methodology. Comparing the constructed fundamental values with real prices, this study finds a 7.3% divergence as at 2013Q2.