Local Housing Market Sentiments and Returns : Evidence from China

This paper examines the impacts of local housing sentiments on the housing price dynamics of China. With a massive second-hand transaction dataset, we construct monthly local housing sentiment indices for 17 major cities in China from November 2016 to October 2020. We construct three sentiment proxies representing the local housing market liquidity and speculative behaviors from the massive second-hand transaction dataset, and then use partial least squares (PLS) to extract a local housing sentiment index from these three proxies for each city considered. The local housing sentiments are shown to have robust predictive powers for future housing returns with a salient short-run underreaction and long-run overreaction pattern. The sentiment impact is comparable with estimates for the U.S. housing market in the literature, implying that the Chinese housing markets are also susceptible to irrational sentiments even under a stringent regulatory environment. Further analysis shows that local housing sentiment impacts are asymmetric, and housing returns in cities with relatively inelastic housing supply are more sensitive to local housing sentiments. We also document a significant feedback effect between housing returns and market sentiments, indicating the existence of a pricing-sentiment spiral which could potentially enhance the ongoing market fever of Chinese housing markets