Interaction Between Real Estate Prices

of Beijing and Stock Prices Based on VAR Model

Wei Li and Ling Jiang

Abstract Real estate market and stock market have great influence on economy.
Since 1998, China’s real estate market and stock market have made considerable
progress. The stock market and real estate market have emerged dramatic fluctu-
ations in recent years. Previous experience abroad shows that house-price bubbles
closely relate to the drastic volatility of stock prices. Therefore, it is significant to
research the relationship between real estate prices and stock prices. Based on VAR
model, this paper investigates the interaction between real estate prices of Beijing
and stock prices during 1999–2010. The result is that there is relevance between
them. One’s variation arouses the other one’ oscillation and the impact is a phased
process. However, the relationship between the two is unstable.

Keywords Interaction • Real estate prices • Stock prices • VAR model

1 Introduction

Since 1998, China’s real estate market and stock market have made considerable
progress. Despite that there are still lots of flaws in the development of China’s
real estate market and stock market, they are playing an increasingly important
role in China’s economic development. At the same time, stock and real estate
are increasingly important part of the consumer’s assets. In recent years, China’s
real estate prices soared and the fluctuations in the stock prices index were quite

Fund Program: Humanity and Social Science Foundation of Ministry of Education (Grant No.
10YJC790158)
W. Li • L. Jiang ()
Business School, Hohai University, Nanjing 211100, People’s Republic of China
e-mail: 184561748@qq.com

E. Qi et al. (eds.), Proceedings of 20th International Conference on Industrial 985

Engineering and Engineering Management, DOI 10.1007/978-3-642-40063-6__97,
© Springer-Verlag Berlin Heidelberg 2013
986 W. Li and L. Jiang

frequent. Therefore, stock prices and real estate prices have become the focus of
attention of common people and even decision-making body of government.
Previous experience abroad shows that there is very close contact between the
extreme volatility of real estate price bubble and stock market. When the link
reaches a certain level, it will accelerate the bursting of real estate price bubble. As
a result, this will cause serious consequences to the whole economy, or even cause a
recession. Therefore, correct understanding of the interaction between stock prices
and real estate prices is not only helpful to people’s investment, but also benefit the
country’s macro-control.

2 Literature Review

Different people hold different opinions about the interaction between real estate
prices and stock prices. Domestic and foreign scholars have conducted a lot of
researches about interaction mechanism of the two. However, the results were not
the same. Taken together, the stand points about the interaction between them are as
follows:
The first view is that there is positive relationship between real estate prices and
stock prices. For example, using empirical analysis, Stone and Ziemba (1993) test
the relationship between price of land, land yields, stock price index and return
rate of the stock market of Japan. The result shows that the variation trend between
price of land and stock prices is positive. Yu Quan-yuan and Kang Zhuang (2009)
take Chongqing Province as an example. They measure the interaction between real
estate prices and stock prices by using staged correlation analysis. The result reveals
that rising stock prices promote real estate prices during the stages from January
2006 to October 2007 and from November 2008 to June 2009.
The second view is that the relationship between the two is negative. For
example, Zhou Jing-kui (2006) uses the data from the year 1998 to 2005 to test
real estate prices and stock prices with bivariate VAR model. The result shows that
the effect of stock price index to real estate sales price index is insignificant, while
the real estate sales price index has very significant reverse effect to stock prices.
The third view is that there is no significant correlation between the two. For
example, Okunev et al. (2000) examine the relationship of real estate prices in U.S.
and the Standard & Poor’s 500 Index (S &500) with linear and nonlinear Granger
causality test. They find that there is non-linear relationship between the two, but
the relationship is not significant. Li Xiao-huan and Feng Xiu-juan (2010) uses VAR
model to test the relationship between stock prices and real estate prices. The result
shows that there is interactive effect between the two. However, there is no long-run
equilibrium relationship between them.
Domestic and foreign scholars have achieved fruitful results on researches of
real estate prices and stock prices. Methods and conclusions of previous studies
are significant to this paper. But there is little research on the relationship between
stock prices and regional real estate prices. This paper selects Beijing as a case to
Interaction Between Real Estate Prices of Beijing and Stock Prices Based. . . 987

study the interaction between stock prices and real estate prices in Beijing. Beijing
belongs to China’s developed eastern region. It is a typical representative to reflect
the relationship between stock prices and house prices in developed areas. Besides,
taking Beijing as an example is conducive to deepening our understanding of the
relationship of the two.

3 Interaction Mechanisms of Real Estate Prices

and Stock Prices

Real estate is both durable consumer goods and investment goods (Shen Yue and Lu
Wen-bing 2008). The interaction mechanisms between real estate prices and stock
prices are different when we treat real estate in different views.

3.1 Interaction Mechanisms Between the Two When Real

Estate Is Treated as Durable Consumer Goods

Many existing researches analyse the relationship between stock prices and real
estate prices from the point of view of wealth effect. They think that change of
stock prices affects individuals’ spending on real estate and finally affects real estate
prices (Ba Shu-song et al. 2009). In this analytical framework, stock prices and real
estate prices show the same variation trend. Because the pathways are different, the
effect is divided into two types- the direct one and the indirect one.

3.1.1 Direct Wealth Effect

According to New Palgrave Dictionary of Economics, direct wealth effect is that

when other conditions stay the same, changes in currency balance will cause
changes in the total consumption expenditure. Therefore, only in the premise that
the stock investment can bring lasting and stable income and stock investment
constitutes an important part of the investors’ wealth, changes of stock prices lead
to changes in the levels of personal wealth and significantly affect individual’s real
estate purchase. Thus, individual’s real estate purchase leads to changes of real
estate prices.

3.1.2 Indirect Wealth Effect

It means that because stock prices rise, people are optimistic about the future
economic development. Thus, they increase their consumer spending. Indirect
wealth effect functions mainly in two ways. Firstly, rise of stock prices reflects high-
988 W. Li and L. Jiang

Rise of
real estate prices buy real Investing in
estate real estate
Rise of
holders’ total wealth
Rise of
Rise of holders’ total wealth
bank credit lines

Rise of Rise of Rise of

Individuals’ investment enterprises’ production stock prices

Fig. 1 Wealth effect between real estate market and stock market

expected current wealth, which directly supports consumers’ confidence. Secondly,

a healthy stock market is a leading indicator of macroeconomic. Cyclic fluctuation
of stock market happens before cyclic fluctuation of macroeconomic. Rise of stock
prices heralds recovery of macroeconomic. Recovery of macroeconomic means high
income and high wealth levels. As a result, there is a clear contact between stock
prices and consumers’ income expectations. In this way, rise of stock prices affect
people’s spending levels. The effect is shown in Fig. 1.

3.2 Interaction Mechanisms Between the Two When Real

Estate Is Treated as Investment Goods

Real estate is both durable consumer goods and investment goods (Kuang Wei-da
and Zhao Yu-hua 2010). Only regarding it as durable consumer goods when we
research its relationship with stock prices is not comprehensive. To make a full
explanation of their relationship, it is necessary to combine the two attributes of real
estate. Thus, the effects between them include at least the following forms:

3.2.1 Wealth Effect

Firstly, real estate prices will lead to increase in the value of collateral used by
families and businesses to borrow from banks (Zhao Xin-dong 2010). Thus, bank
lines of credit increase. On the one hand, this will help families throw their surplus
cash to stock and other capital market, which promotes increase of stock prices. On
the other hand, companies can get more loans as a follow-up investment, which will
improve the expected value of their stocks and inevitably promote the rise of their
stock prices.
Secondly, from a portfolio perspective, rise of stock prices will result in increase
of investors’ total wealth and increase of the proportion of stocks in the portfolio
Interaction Between Real Estate Prices of Beijing and Stock Prices Based. . . 989

(Song Bo and Gao Bo 2007). To rebalance their portfolio of assets, investors will
sell part of stocks and purchase other assets. Similarly, real estate also has wealth
effect to stocks.

3.2.2 Crowding Out Effect

Both stocks and real estate are regarded as risk assets. There is crowding-out effect
between them. Rise of stock prices will lead to increase of the proportion of risky
assets in the total assets of investors. In order to balance risk, investors will reduce
their risk assets and put funds into other assets, which leads to the decline in real
estate prices (Zhao Wei et al. 2011). Similarly, real estate also has crowding out
effect to stocks.

3.2.3 Substitution Effect

If other conditions remain the same, change of relative incomes of assets will
produce mutual replacement of assets. Funds will be transferred from the relatively
low-income assets to the relatively high-income ones. If income of real estate is
higher than that of stocks, funds originally invested in stocks will be transferred into
real estate, thus, real estate prices rising rapidly (Lu Min-feng and Zhang Yu-jie
2011). Similarly, stocks also have substitution effect to real estate.
Without impact of external conditions, interaction mechanism of the two assets
is mainly formed by the interaction of the three effects. When the wealth effect is
greater than the sum of crowding-out effect and substitution effect, real estate prices
and stock prices will show the same trend. When wealth effect is weaker than sum
of crowding-out effect and substitution effect, prices of the two assets will show the
opposite trend.

4 Empirical Analysis of Interaction Between Beijing Real

Estate Prices and Stock Prices

Are there mutual relations between real estate prices and stock prices? The
following paper will answer the question by testing interaction between Beijing real
estate prices and stock prices by empirical analysis.

4.1 Data Selection and Description

The year 1998 is a watershed for marketization of China’s real estate market. In
the end of 1998, China’s welfare housing system was abolished and monetization
990 W. Li and L. Jiang

Table 1 Result of stationary test

Stationary test Variable LNSHZ LNHP
Second-order non-stationary ADF statistic 3.973360 7.173750
1 % threshold 2.816740 2.847250

housing distribution system started. In addition, in 1998, China’s stock market set
foot on formal development road along with the introduction of “Securities Act”
(Gao Bo and Mao Feng-fu 2003). Considering the data available, this paper selects
the data from 1999 to 2010. Specifically, the paper takes the representative Shanghai
Composite Index (SHZ) as an indicator to measure the overall changes in stock
market (Zhao Xing-qiu 1999). Real estate price is defined as the ratio of commercial
housing sales and commercial housing sales area (Pi Shun and Wu Kang-ping 2006).
It is named HP. In order to smooth the data and eliminate heteroscedasticity, their
logarithms are calculated respectively and named LNSHZ and LNHP to represent
stock prices and real estate prices.

4.2 Model and Econometric Test

4.2.1 Stationary Test of Variables

Data stability is the base of the effectiveness of time series analysis (Xu Long-bing
and Fu Ge 2001). If non-stationary time series are used as stationary time series in
regression analysis, the analysis and projection will be invalid. Therefore, stationary
test has a great influence on the effectiveness of regression analysis (Tang Man-ping
and Cheng Zhe 2012). This paper examines stationary of the variables by ADF
test. The results of stationary test in Table 1 show that the second-order differences
of LNSHZ and LNHP pass the test. The following paper will further explore the
relationship between LNSHZ and LNHP after difference by bivariate VAR model.

4.2.2 Stationary Test of VAR Model

VAR model is generally used in the relevant time series forecasting and dynamic
impact of random disturbance to variable system, so as to explain the impacts
of various economic shocks on economic variables (Gu Yao and Lu Li-na 2006).
Firstly, the paper uses stationary test to examine the steadiness of bivariate VAR
model. Steadiness of bivariate VAR model is the base of impulse response function
analysis (Chen Liu-fu and Liu Hou-jun 2007). As shown in Fig. 2, all the
eigenvalues are located within the unit circle. That means all the eigenvalues are
smaller than 1. Therefore, the system is a stable one (Zhou Lian et al. 2008).
Interaction Between Real Estate Prices of Beijing and Stock Prices Based. . . 991

Fig. 2 Stationary test of

VAR model

4.2.3 Impulse Response Function Analysis

Explaining a single estimation value of parametric of VAR model is very difficult.

In order to draw a conclusion of VAR model, the impulse response function of
the system can be observed (Zhang Hong and Zhang Fei 2013). Impulse response
function is used to analyse the dynamic impact of a variable on a system when the
variable is under shock (Liang Yun-fang et al. 2006). The impulse response function
analysis results of LNSHZ and LNHP are showed in Fig. 3.
The figure shows the process of impulse response. (1)After shock, the consequent
reaction of each variable is gradually converging to 0, so the system is stationary and
the shock will gradually disappear without memory effect. (2)After giving stock
prices a positive standard deviation information shock in the present period, real
estate prices show rising phenomenon in the first period and peak in the third period.
Then the prices reverse sharply in the fourth period and as a result, stock prices and
real estate prices turn into a negative correlation. In the subsequent periods, real
estate prices present concussive posture and gradually decrease to 0. This indicates
that putting external shocks to stock prices will bring positive and negative series
of shocks to real estate prices. (3)After giving real estate prices a positive standard
deviation information shock in the present period, stock prices remain the same in
the first period, show an upward trend in the second period, and subsequently reach
the lowest point in the third period. Then in the subsequent periods, stock prices
present concussive posture and gradually decrease to 0, which is the same with the
response of real estate prices.
It can be concluded that stock prices and real estate prices spiral. Table 2 shows
the results of Granger causality test of real estate sales prices and stock prices,
at the significance level of 5 %. As can be seen from the results, there is causal
992 W. Li and L. Jiang

Fig. 3 Result of impulse

response function analysis

Table 2 Result of granger causality test

The direction of causality Lag F value P value Decision:
LNSHZ ! LNHP 1 4.45427 0.06782 Denied
LNHP ! LNSHZ 1 2.62758 0.14368 Accept
LNSHZ ! LNHP 2 2.97145 0.14112 Accept
LNHP ! LNSHZ 2 6.64788 0.03904 Denied
LNSHZ ! LNHP 3 10.3852 0.08910 Accept
LNHP ! LNSHZ 3 2.98146 0.26118 Accept
LNSHZ ! LNHP 4 NA NA –
LNHP ! LNSHZ 4 NA NA –

relationship between the two in the lag of 1–2. When the lag is longer, there is no
longer correlation between them. The outcome also confirms the results of impulse
response function analysis. It proves that there is phased correlation between the
two and the correlation becomes smaller in the later stage.
Interaction Between Real Estate Prices of Beijing and Stock Prices Based. . . 993

5 Conclusions and Recommendations

This paper studies the interaction between Beijing real estate prices and stock prices.
The results are as follows. Firstly, the results of impulse response function analysis
present that there is correlation between the two. One’s change will make the
other one present concussive posture, which is the result of interaction of wealth
effect, substitution effect and crowding-out effect between them. I believe that the
root of the strength of relationship among the three effects is capital adequacy.
Secondly, from the results of Granger causality analysis, the relationship between
real estate prices and stock prices presents significant phased characteristics and the
relationship is instable.
Based on the findings of interaction between Beijing real estate prices and stock
prices, I propose the following:
Firstly, weaken the correlation between real estate prices and stock prices by
perfecting financial markets, broadening investment channels and dispersing market
risk. In the financial markets filled with a variety of financial instruments, if investors
have a lot of options, they will not only make chose between the two. In this way,
the negative correlation between them will be reduced and as a result, the risk of
financial markets will be degraded to a great extent. Currently, there are only several
types of financial instruments. Derivative financial products such as commercial
paper, corporate bonds, mutual funds, etc. are not flourishing. The development of
these products is necessary for the prosperity of the financial markets.
Secondly, regulate financial markets by strengthening market supervision and
draft correct policies. Many financial products have not yet been developed. In
addition to the reason that these financial products themselves are not ripe, inad-
equate supervision is also a key cause. Inadequate supervision leads to ambiguity of
regulatory functions of various departments and makes the market more instable.
Effective supervision is precondition of the development of financial markets.
Otherwise, free market economy is just words empty. Besides, sectors should plan
the two markets as a whole. When they draft relevant policies, the interaction
between the two and fluctuations of economy caused by them cannot be ignored.
Thirdly, investors should concentrate on investment rather than speculation.
Thus, stock investment can bring lasting and stable income and then drives boom of
other market. Investors should be careful to determine a reasonable portfolio of real
estate and stock. In different periods, they should determine different investment
ratios in accordance with the asset quality.

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