Is the China Housing Market in a bubble?

Background: Over the last two decades China’s housing price index has risen by at least 70%. According to Reuters, average new home prices in China’s 70 major cities rose a record 9.6%in the year to October 2013; it was the tenth straight month of year-on-year increases. In 2016, Chinese cities account for the top eight rankings in Global Residential Cities Index according to International Real Estate Group Knight Frank. (Lenaghan, 2016) The accelerated growth is concentrated in Tier 1 cities and Tier 2 cities. In view of such soaring prices, the questions of house price dynamics and housing bubbles need to be addressed at China housing market, especially the segment where house prices surge the mos.Research questions: This paper poses two research questions:RQ1.What are the main drivers of China house prices?RQ2.Is there a bubble in China’s housing market?Research methodology: The paper describes the application of combined enhanced rigorous econometric frameworks, such as Ordinary Least Square (OLS), Granger Causality, and the Vector Error Correction Model (VECM), Principal Component method to provide an in depth understanding of house price dynamics and bubbles in China. Thorough analysis has been performed on the diagnostic concerns and potential econometric estimate issues.Findings: The empirical results presented reveal China house prices are driven primarily by three key factors: interest rates, GDP, China share market index. It finds these main drivers have long term equilibrium in relation to house prices, and any short term disequilibrium always self-corrects over the long term due to economic forces. The existence of long term equilibrium in the housing market suggests it is unlikely to be in a bubble in China. (Diba & Grossman, 1988; Flood & Hodrick, 1986).China house price performance reacts strongly to interest rates and share market performance, reflecting both the importance of house financing and the close relationship between the share market and the real estate market.Originality and value: The principal contribution of this paper is that it is the first rigorous study of housing bubbles in China at the national level, based on the top 13 cities’ house prices. Key policy implications presented in this research include the need for governmental affordability programs, and a balanced and complementary combination of financial policies and monetary policy decision making.