Finance Department Study Uncovers Way to Limit Future Real Estate and Stock Market Bubbles
August 29, 2012
Sandro Andrade and Timothy Burch appeared on the PBS program “Nightly Business Report” Aug. 31 to discuss their research into market bubbles.
Market bubbles like the one that preceded the recent housing collapse would be more preventable and less severe if governments and regulatory bodies collected and shared information with the public about the factors that determine an asset's value. That, according to a new study from the School’s Department of Finance.
The research, to be published in the Journal of Financial and Qualitative Analysis, focused on China's 2007 stock market during a six-month bubble period when stock prices nearly tripled and trading activity nearly quadrupled, only to return to “normal” levels after the bubble deflated. China’s stock market was studied because of its wealth of available data, but researchers say the findings are applicable to other assets such as the real estate market and can have similarly large effects.
The study found that stocks with a large amount of analyst coverage had significantly smaller bubbles than those with no analyst coverage. For example, stocks with 20 analysts reporting on them developed bubbles that were more than 60 percent less severe than stocks with no analyst coverage.
“We ran into trouble with the recent housing bubble because novice buyers falsely assumed there would always be a future buyer willing to pay more," said the School’s Timothy R. Burch, associate professor of finance, who conducted the study along with Sandro C. Andrade, assistant professor of finance, and Jiangze Bian of the University of International Business and Economics. “This problem is much more severe when there is greater investor disagreement about an asset's value. Our research shows that making relevant information about an asset readily available reduces disagreement, which in turn makes bubbles less severe."
The researchers suggest that to limit real estate market bubbles, governments and regulatory bodies should level the playing field for all participants by freely disseminating information about transactions, appraisals, rental yields, vacancies, demographic/migration trends, prospective changes in zoning laws, and real-property borrowing statistics. Similarly, the researchers say that to limit bubbles in the stock market, government agencies could collect and disseminate an assortment of information and even subsidize analyst research where needed.
“The Federal Reserve or another government body could take steps to help coordinate the beliefs of all of the players in the real estate market," said Andrade. "This could be achieved by creating a ‘Kelley Blue Book’ for real estate, a centralized, well-promoted website where everyone could go before making real estate decisions. Providing such information could go a long way in reducing the odds and severity of future real estate bubbles.”