Journal of Real Estate Finance and Economics, 29:1, 99±118, 2004
# 2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
Dynamics of Urban Residential Property PricesÐ
A Case Study of the Manhattan Market
Deutsche Bank, New York, New York 10005, U.S.A.
In a multivariate vector autoregression framework, this paper investigates the weak ef®ciency of the urban
residential real estate market and the cause of weak ef®ciency. An error correction model is used to estimate long-
term relationships among apartment prices and adjustment speed from disequilibrium to equilibrium. Based on a
unique dataset of the Manhattan market, the ef®ciency of this market, seasonal stationarity of property prices, and
the weak exogeneity of leading sub-markets are studied. Our results indicate that, in a market of less
heterogeneity and higher transaction volumes, the weak ef®ciency hypothesis is rejected as in previous studies.
This result implies that heterogeneity and lack of transaction information may not be the direct source of market
inef®ciency. Meanwhile, it is found that there are stable long-term relations among prices of different sub-
markets. Interestingly, the price of one-bedroom co-operatives (co-op) is weakly exogenous. This implies that the
starting co-op for most home buyers in urban areas is a leading indicator of the entire market, which contradicts
the claim that high-end luxury co-op leads the market.
Key Words: cointegration, error correction model, equilibrium, exogeneity, heterogeneity, likelihood function,
liquidity, market ef®ciency, seasonality, stationarity, vector autoregression
1. Background and motivation
The dynamics of house pricing has been of constant interest in real estate literature.
Signi®cant effort has been devoted to testing the ef®ciency of the housing market. Fama
(1970) de®ned three types of ef®ciency based on the information content. What is relevant
to this article is the weak ef®ciency. In a weakly ef®cient market, the excess return is zero
when past prices and returns are available. Previous research, in general, rejected the
weakly ef®cient hypothesis. Both house prices and excess returns exhibit serial
correlation, which makes it possible to predict future prices and excess returns using
historical prices and returns. Illiquidity of the market, which is related to high transaction
cost; the heterogeneity of the apartments and dif®culty in obtaining transaction
information; shortage of supply due to high construction cost of housing; and uniqueness
of being both consumption goods and investment vehicle, as well as government
regulation were often cited to explain the inef®ciency. Cho (1996) presented a
comprehensive survey on these results.
Recent research has focussed on explaining the cause of inef®ciency. In an empirical
study, Abraham and Hendershott (1996) documented that prices in three northeast cities