Essays in macroeconomics and finance

Vasilopoulos, Konstantinos and Pavlidis, Efthymios and Tayler, William (2020) Essays in macroeconomics and finance. PhD thesis, Lancaster University.

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Abstract

This thesis comprises three essays in macroeconomics and finance. In the first chapter we investigate the business cycle, property-price and investment dynamics when there is competition between households and firms for real estate. We introduce a construction sector into a RBC framework, which uses land, capital and labour to produce both commercial and residential real estate. This market structure activates a ‘real estate substitution channel’, where economic disturbances which alter the demand for one type of real estate, by affecting the overall costs of real estate production, endogenously create a substitution with its counterpart. For example, an increase in demand for residential real estate, also increases the cost of producing commercial structures which reduces the amount demanded by firms. In turn, this crowds out commercial real estate which affects the goods market in a similar way to an adverse aggregate supply shock. The estimated model reveals that housing preference shocks explain the largest part of the variation in property prices and residential investment, while commercial real estate prices are primarily driven by technology shocks. The second topic proposes a novel approach for testing for rational speculative bubbles in segmented capital markets. The basic idea is that, under capital controls, heterogeneity of speculative expectations across international equity markets causes financial assets with identical cash flow promises to trade at different prices. Because these deviations from the law of one price inherit the properties of the speculative bubble process, they display periods of explosive dynamics and have predictive power for future movements in equity prices in sample. These two hypotheses can be examined empirically using sequential unit root tests and predictive regressions. An attractive feature of this approach for bubble detection is that it does not require the specification of a model for market fundamentals, thus mitigating the well-known joint hypothesis problem. The focus of the paper is on mainland Chinese companies that cross list shares in Hong Kong. China is an ideal setting for our analysis because of the significant restrictions on capital movements imposed by the authorities and the turbulent behaviour of its stock market over the last decades. Finally, the third chapter investigates the causal effect of consumer confidence on the housing market dynamics, using narrative evidence. We adopt an external instrument approach that is using mass fatalities to identify exogenous variations in consumer confidence. We find that adverse sentiment shocks can negatively affect housing demand with a strong and prolonged reduction of house prices and new houses sold. The deterioration of sentiments worsens homeownership conditions, causes a response of monetary policy, and exacerbates real consumption spending. In a counterfactual experiment, we assess the importance of the housing market by restricting the response of the housing market variables to sentiment shock to be zero. We find that, the housing market can propagate the effect of the sentiment shock to the rest of the economy. The effect becomes particularly evident in longer horizons, specifically after one year, where the deviation from the unrestricted model becomes substantial.