Finance: What is the definition of a housing market bubble and how can you detect it timely? (Early Warning Systems)

Résumé du document

In 2009 the US faced a recession that was known worldwide. Newspapers, television, and all of the media addressed this problem to a bubble in the housing market. But before blaming the recession on anything, the first question to ask is "What is a bubble?"
Unfortunately, there is not a consolidated or clear definition for "bubbles" in economics (Holzhey, 2013). Nevertheless, there are some descriptive definitions that can help to the general understanding of what a bubble is. Kindleberger (1996) defines a bubble as an upward price movement over an extended range that then implodes. Whereas Stiglitz (1990) mentions that a bubble is when fundamental factors fail to justify a determined price. Similarly, Smith and Smith (2006) stated that a bubble is defined by market prices not being justified by assets' anticipated cash flows.

Even though there is no recognized definition for a "bubble" in the economic jargon according to Holzhey (2013), there are some elements that can be found as essential to other authors that help to understand the meaning of a bubble. From the previous definitions one can identify that a bubble has the following key elements: price, normally referring to overprice; and the lack fundamentals or basis to sustain the high price. Therefore, based on the previous literature a bubble can be defined as a high market price with no fundamentals or unsustainable evidence to support it.

Extraits

[...] (2006). Bubble, Bubble, where's the housing bubble". Brookings Papers on Economic Activity Stiglitz, J. E. (1990). Symposium on bubbles. The Journal of Economic Perspectives 13-18. Sternberg, J. (2012, Aug 16). China, the world's greater fool? [...]

[...] Wall Street Journal. Retrieved from http://search.proquest.com/docview/1033526260?accountid=11643 Andrew Berg, Eduardo Borensztein and Catherine Pattillo (2004), “Assessing Early Warning Systems: How Have They Worked in Practice?”, IMF Working Papers No. 04/52. Gourinchas Pierre-Olivier, Landerretche Oscar and Valdés Rodrigo (2001), “Lending Booms: Latin America and the World”, CEPR Discussion Papers. Levitin, A & Wachter, S. (2012). Explaining the housing market bubble. [...]

[...] - Cyclical causes: the fluctuations of the interest rate could be a reason of a housing market bubble indeed if they are very low modest households can take a loan and buy at a too higher price. Moreover the inflation and especially the anticipation of inflation could be a reason, because households want to protect themselves from the monetary erosion. We can add the report of investment like in the 2000's. All of these cyclical causes can lead to a bubble of the housing market and so to a krach. [...]

[...] The choice of the indicators to forecast a crisis depends on the economy itself, and that's the reason why there are different kinds of Early Warning Systems. The most common way is the “scoring approach” developed by Hawkins and Klau in 2002.This method consists in classifying the early warning indices under three groups: 1. Currency Crisis 2. Balance of Payment Crisis 3. Banking Crisis Each of the groups is given a weight of a high weight means that the variables of the observed group are very volatile. [...]

[...] Conclusion To conclude as we mention before, it is very hard to have a perfect definition and a perfect understanding of the housing market bubble due to the fact that is a very controversial subject with a lot of different point of view. In addition, a bubble could exist from many different factors. Some will need an intervention from the central banks or from the government that's why it is a very controversial subject. The development of forecasting techniques such as the Early Warning Systems and the understanding of the macroeconomic environment helped economists to explain what were the causes and the consequences of the previous crisis. [...]