LEAD-LAG ASSOCIATION OF MORTGAGE RATE WITH HOUSING PRICE

INTRODUCTION AND BACKGROUND In this research we explore the association of internal factors and other information externalities in the determination of residential housing price to observe the cross-correlation dynamics of housing market. In recent years, the housing markets have experienced some episodes of large proportions as a result of persistent increase and then followed by significant decrease in housing demand and their prices. The current housing episode appears significantly worse and perhaps the most severe in the recent history of housing market. The current housing market episode arise with the subprime mortgage lending surge, which in turn increased the homeownership rates significantly and caused sharp appreciation in housing prices. This sequential association then reversed itself due to the economic capacity that is finite and limited. Consequently, the subprime mortgage crisis weakened the housing market and eventually the economy as a whole. Since the peak of housing market (in 2006), the Home Price Index has declined considerably and created a domino effect of widespread mortgage defaults. In addition, the spillover effect of this housing crisis spread into other financial/economic markets and is likely to be prolonged due to their domino effect characteristics. Thus, this has important implications for market participants and regulators interested in identifying risk factors by understanding the cross-correlation dynamics of housing market. Therefore, the objective of this research is to observe the nature of the cross-correlation dynamics of mortgage rate and its relationship with housing price over time. To this endeavor, we estimate the model of home values using several internal and external factors. These factors may contain physical characteristics of a home as well as economic characteristics of that time period. Thus, isolating the time delayed effect of mortgage rate on the housing price after controlling for relevant factors, primarily internal factors. In this study, we have considered only single family housing. Therefore, zoning differentials is not a major factor. Zoning differentiates land use as per its classifications. Different zoning classifications have different conditions and characteristics (see, Phoebe, Koenig, and Pynoos 2006; Shoked, 2011). Other aspects of zoneing and its effects on the price of house has been studied by researchers (Cho, Kim, and Lambert, 2009; Mukhija, Regus, Slovin, and Das, 2010). These suggest that zoning significantly affects housing prices (Glaeser and Gyourko, 2002). Housing market plays a significant role as leading indicator of the economy, and therefore understanding the market dynamics cannot be overemphasized, especially in light of the recent housing market turmoil and its effect on the economy. Since, the movements in the housing market will likely continue to play an important role in the business and economy (Bernanke and Gertler, 1995), understanding the market mechanism, specifically the lead-lag relationship between factors can offer mortgage lenders and insurance providers among other participants a notion about the association of these factors, and thus, provides a better understanding for designing appropriate policies and products (Stanton and Wallace, 1998). This insight of such association may then be applied to the formation of new regulations and guidelines. As a result of such importance of the housing market on the economy, researchers have devoted much of their effort to identify factors that determine the housing market mechanism (Sander & Testa 2009; Lyytikainen, 2009; Fratantoni & Schuh, 2003; Taylor, 2007; Bradley, Gabriel, & Wohar, 1995; Vargas-Silva, 2008). Many factors have been cited (Ewing & Wang, 2005; Kearl, 1979) as sources of housing market dynamics; among these, housing price (Rapach & Strauss, 2009) and housing starts (Lyytikainen, 2009; Ewing & Wang, 2005; Puri & Lierop, 1988; Huang, 1973) play a very important role. …