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Volatility in Housing Markets (Part 2 of 2) July 27, 2008

Posted by DustinRJay in Uncategorized.
15 comments

This is a follow-up to my previous post about volatility in the housing market.  For those that are looking to buy or sell a house, you may want to research what the worst and best annual scenario may look like.

The results and graph using the same data set as my previous post are below:

  • P90: -5.6% (90% chance of price growth being greater than -5.6%)
  • P50: +5.9% (50% chance of price growth being greater than +5.9%)
  • P10: +19.9% (10% chance of price growth being greater than +19.9%)

Inflationary effects like rising household income and rent increases will continue and house prices will continue to have softness as long as there is high inventory.  I believe this will entail a soft landing for the Calgary real estate market with the market chugging along between P90 and P50 for between 2-7 years.

Volatility in Housing Markets (Part 1 of 2) July 20, 2008

Posted by DustinRJay in Calgary real estate, volatility.
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5 comments

In general, housing prices have a low volatility compared to other asset classes.  This is due to the underlying fundamental value (rents) being a relatively stable cash flow.  This compares against stocks which have larger variance in earnings and therefore larger volatility in price.

A lookback at historical real estate volatility can help to give a forecast probability cloud.  By comparison, the S&P 500 has a VIX index which is representative of S&P 500 volatility over the next 30 day period and is referred to by some as the fear index.

A quarterly calculation of year over year price changes by histogram for Calgary real estate from Q3 1977 to Q1 2008 helps identify the scale of price changes that could occur in one year.  The results are below:

  • P90: -5.6% (90% chance of price growth being greater than -5.6%)
  • P50: +5.9% (50% chance of price growth being greater than +5.9%)
  • P10: +19.9% (10% chance of price growth being greater than +19.9%)

Furthermore, the probability of an event occurring that is above the P10 or below the P90 for 5 consecutive years is 1 in 100,000 for each (i.e.: (1/10)^5 = 1/100,000).  The shortfall of this kind of approach to volatility is that this calculation is not statistically independent as bear and bull markets typically last between 2-10 years.

What this analysis demonstrates is that even if a bearish scenario is the right approach, Mr. Market could take a very long time to unwind.  The following graph illustrates what 5 consecutive P10, P50 and P90 events would look like and is meant to represent the best case, best guess and worst case respectively.

Click, Whirr – Betting the Shortcut July 15, 2008

Posted by DustinRJay in Calgary real estate, market behaviour.
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6 comments

The failure in the US housing market was not a black swan as some have described it, but an error in understanding and managing collective risks.

Some of the psychological phenomena that may have contributed to the housing boom and bust are explored in a book called “Influence – The Psychology of Persuasion.” Some of these are:

1.  Social Proof – Truths are Us

  • Banks rely on other banks to determine risk management practices and safe lending procedures
  • Real estate investment organizations like Alberta REIN have a bandwagon effect or crowd psychology (see photos here)

2.  Authority – Directed Deference

  • Appeal to authority of a “REALTOR®” (don’t forget the caps lock!)

3.  Scarcity – The Rule of the Few

  • Appeal to buy due to lack of supply (low housing inventory in Calgary 2006 to mid 2007)

4.  Commitment and Consistency – Hobgoblins of the Mind

  • The real estate market has only gone upwards for the past 10 years and therefore is perceived as having no risk

And on that note, I’ll leave you with a YouTube video of last weeks bank run on Indymac as a demonstration of crowd psychology.  Enjoy!