An empirical analysis of Malaysian housing market: switching and non-switching models

Abstract

Increasing inflows of foreign investment particularly in the real estate sector in the early 1990s, has contributed to the building up of “bubble” in the economies of several Asian countries. In 2004, house prices increased rapidly in several countries such as South Korea, Hong Kong and Singapore (World Report, 2004). The rapid increase in prices has led economists to believe that a ‘bubble’ has form in the housing market. A housing market bubble occurs when house price increases are not justified by macroeconomic fundamentals and other underlying factors (Xia and Tan 2006). The effect of housing bubble bursts is seen in the loss of value to owners of capital, increase unemployment, slowing down of the economy particularly in housing-related sector.

This study empirically test whether a bubble exist in the Malaysian Housing Market for the period 1990 to 2004. Using a general to specific approach from a simple multivariate liner regression model (OLS) to more sophisticated models such as Vector Error Correction Model (VECM), Vector AutoRegression (VAR), regime-switching (Markov-Switching),GARCH model and MS-GARCH, our result suggests that a semi-rational bubble does exist in the Malaysian housing market in 1997:Q1 to 1998:Q2. The deviations or fluctuations of the Malaysian House Price Index cannot be explained by the macroeconomic fundamental variables such as income, interest rate and inflation. Furthermore, the result also implies that Malaysian housing market is inefficient market due to the slow adjustment process towards its long run equilibrium price. The mean and variance of the MHPI is significantly different in the two states (boom and burst) which suggest that the Malaysian housing market had experienced a boom and bust of house price bubble prior to the occurrence of the 1997 Asian financial crisis. The results of switching model approach support the changing behaviour of MHPI in different economic states, implying possible existence of bubbles in the Malaysian housing market.