HKMA - Asset Pricing and Central Bank Policies

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Asset Pricing and Central Bank Policies: The Case of Hong Kong

Central bankers can ignore asset prices only at their own peril. Asset markets can affect price stability, stimulate

unsound banking practices and distort resource allocation. Asset prices can surge to levels incompatible with economic

fundamentals, creating bubbles which inevitably burst. Among the first casualties of a crash are typically the banking

system, government budget as well as domestic income and employment.

The case study of Hong Kong illustrates the scope and limitations of the central bank's role in asset pricing

developments. It shows how, in spite of considerable vigilance on the part of the authorities, bank lending can fuel

soaring asset prices. It also shows how simple indicators can be developed to detect signs of speculative excesses. The

prudential measures used by the authorities in Hong Kong can contain the extent of irrational exuberance?and contribute

to the soundness of banks. But such measures have not been very successful in preventing bubble formation. Bubble

containment also requires action in fields outside traditional monetary and banking policy. For example, to moderate

price fluctuation in the property market, the HKSAR government has recently embarked on policy measures to relaxsupply side constraints.

Hong Kong has seen quite a few sharp swings in asset prices in the past two decades. Stock prices, for instance, soared

in 1981, 1987, 1993 and 1997 to unusual levels of valuation. Price-earning multiples exceeded twenty, before crashing

by more than a third on each occasion. Property prices rose by more than 20% per annum on seven occasions in the past

10 years, with an increase of about 40.5% in 1992. Buoyed by optimism about Hong Kong's future and its beneficial

relations with China, home prices, with historically low rental yields of less than 3% before the onset of the Asian

financial turmoil in the second half of 1997, may well qualify as a bubble.

A major policy concern is the impact of asset prices on aggregate demand and inflationary pressure. Hong Kong's

experience suggests that rising property prices have played a significant role in raising rents and the housing-cost

component of consumer prices. Stock prices do not seem to affect inflation directly, but nonetheless contribute to

aggregate demand by increasing business investment in fixed assets. The impact of falling asset prices on the economy

and the banking system also appears manageable, as the degree of leverage among corporations is not excessive andbank lending practices remain prudent.

Recent research suggests that the channels of monetary transmission are broad and diverse. Traditional indicators employed bythe authorities, including real economic activity, consumer prices and external payments position, often do not provide adequatediagnostic tools for analyzing the impact of policies being implemented. Early warning signals of emerging imbalances may not beadequately captured or fully understood. Opportunities for policy adjustments may be missed .

Of particular importance among the channels of monetary transmission is the role of asset prices. Since the mid-1980s whenconsumer prices, as well as interest rates, began their secular descent, asset prices have risen very substantially acrosscountries. Initially, the price appreciation was regarded as a benign revaluation of assets in the light of new circumstances.Gradually, however, it became widely recognized that asset prices can be transmitted to consumer prices (through housing costs)

and can influence aggregate demand through the wealth effect . In addition, the growth of financial distress in many countries hasfocused policy attention on rising asset prices, as well as the role of bank lending in this process.

It is now well known that asset prices can at times rise to levels not supported by economic fundamentals, creating what is knownas bubbles . Often an initial price increase may be perfectly rational. But the price increase itself may stimulate speculativeactivity, as trend followers?and momentum players?join the band wagon in a buying frenzy. Prices thus accelerate, often toirrational levels. Bubbles are highly vulnerable to changes in perception, sentiment as well as the underlying economic reality. Anysurprise or disappointment can produce panic, with short-term traders rushing to sell or reverse their existing positions, resulting ina collapse of asset prices. As many countries have learned, the more removed asset prices are from fundamentals, the greater isthe anguish of the fall.

This case study provides a preliminary review of Hong Kong's experience in the past two decades with the cycles and volatility of

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asset prices. Among the main objectives of this review are:

To identify the factors that influence asset price movements;

To assess the impact of asset pricing on the real economy;

To look for indications, or early warning signals, of asset bubbles;

To draw lessons for policy formulation.

Asset prices in Hong Kong

Hong Kong has enjoyed dramatic growth over the past two decades. The standard of living has improved substantially. Per-capitaGDP (in constant 1990 prices) was US$7,873 in 1980. In 1997, it more than doubled to US$16,572. Rising wealth has stimulatedthe demand for assets, particularly real estate and equity. The Hang Seng Index rose 624% and property prices 600% during theperiod (Chart 1). Meanwhile, the consumer price index (CPI) increased by 275% and nominal GDP per capita by 629%. In realterms, shareholders have seen capital gains of 93% and property owners 94%. Whether such an appreciation is warranted byeconomic fundamentals requires careful assessment, a task we take up in the sections below.

The impressive gain in asset prices was accompanied by pronounced cycles and considerable volatility. The rise and fall of stockprices coincided with that of property prices between 1980 and 1983. The fall was accentuated by the weakness of the bankingsector and by political uncertainties. More recently, stock prices rose substantially in January 1994, went through a year ofcorrections as interest rates rose, and then started another upswing early in 1995 and reached a peak in August 1997. Propertyprices surged in April 1994, dropped 30% in a few months before recovering and peaking in the second quarter 1997. (see Tablebelow)

With the onset of the Asian financial turmoil and its contagion effect on Hong Kong in the second half of 1997, both the stock andproperty markets experienced sharp corrections. Stock prices fell by over 50% from its peak in August 1997 and reached a 3-year


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low of 7,909 on 12 January before gradually picking up in the subsequent months. In the property market, coupled with theannouncement of the government's policy in October 1997 to increase the supply of housing units, the interest rate hike resultingfrom Asian financial turmoil sent property prices down by 20% to 30% in the last few months.

Factors influencing asset prices

Among the fundamental factors that influence asset prices are:

Interest rate movements, which are influenced by US interest rates due to the link of the HK$ with the US$ under thecurrency board arrangements;

Earnings and profitability, including tax considerations;

Public confidence, which are related to political developments;

Availability of bank credit to finance asset purchases;

Capital flows which reflect foreign demand for domestic assets.

In the case of Hong Kong, there are special factors that have caused property prices to move sharply in recent years:

Demographics - Hong Kong population rose to 6.62 million persons by end 1997, an increase larger than originallyanticipated. Part of the reason for more rapid population growth was the return of Hong Kong residents who migrated earlier

and also a larger influx of immigrants from mainland China. Housing demand has risen accordingly;

Supply considerations - Hong Kong has one of the highest population densities (per unit of habitable land) in the world. Upto 30 June 1997 incremental land supply was governed by the Sino-British Joint Declaration, which limited annual releasesto 50 hectares. Although in practice more land was actually released, it did not keep pace with demand.

Higher incomes - As Hong Kong residents become wealthier, they upgrade their homes or purchase larger units. The rapidincome growth has therefore put considerable pressure on the upscale or luxury residential properties;

Changes in planning procedures - Due to environmental, infrastructural and social considerations, the lead time has gone upfrom 2 to 3 years to take a project from the planning stage to marketing. The delay has added to the housing cost.

Price expectations ?with domestic inflation generally higher than the nominal interest rates, investment in real assets tendedto be a good protection against inflation. Such expectations fueled property speculation.

Property demand has for these reasons tended to exceed supply. In addition, bank credit was generally available. Not surprisingly,there have been periods of sharp increases in prices since the late 1980s.

Recent research also suggests that asset prices are closely related to domestic liquidity, which can be influenced significantly bythe degree of globalisation and international capital flows (Pepper, 1994). Free liquidity?- that is the liquidity expansion above andbeyond the demand of the real economy - can play a key role in asset pricing. (For a fuller account of and rationale for the use offree liquidity, see HKMA (1997).) In the case of Hong Kong, free liquidity is defined as the nominal growth of M2 (in HK dollar)

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minus nominal export growth, since Hong Kong is a highly trade oriented economy. The greater the difference between M2 growthand export growth, the greater the amount of free liquidity left for asset market investment.

Chart 2 shows a relatively close relationship between free liquidity and the Hang Seng Index. Buoyed by optimism about USinterest rates and confidence over the reversion of Hong Kong to the Mainland of China in 1997, free liquidity expanded between1995 and September 1997. The liquidity injection sent asset prices to a higher level during this period. Alongside the slowdown ineconomic activities brought by the Asian financial turmoil, growth in M2 decelerated, thus bringing the rate of expansion of freeliquidity down significantly from around 20% in September 1997 to 5% in January this year.

The link between free liquidity and real estate prices is less obvious (Chart 3). There are many other factors that influence homeprices, as discussed in paragraph 11 above.


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Detecting asset bubbles

In the longer run, economic factors determine the movement in asset prices. In the short run, however, prices can fluctuate morethan warranted by the fundamentals, often giving rise to bubbles with very high valuation. [A conceptual framework for explainingthe existence of bubbles?and noises?is provided in IMF (1995), pp 175-182.] Typically, these bubbles are followed by panic andcrashes when assets are sold at deep discounts, as in 1929 and 1974 in the US. We have developed simple models to assess thepotential impact of economic factors on asset prices (Annex 1). The divergence between actual prices and those predicted by the

models provides an indication of market sentiment, which often involve excessive optimism or pessimism. For a similar analyticalprocedure, see Ito and Iwaisako (1996) and Kahkonen (1995).

Policy makers at times draw on past experience to detect asset bubbles. In the stock market, for example, extreme historicalvalues of the price-earnings ratio can serve as a benchmark or reference point. The experience of the US in 1996 provides anexample. As the Dow Jones index showed a price-earnings ratio above 20, which was unusual for the US stock market, theFederal Reserve Chairman began to sound a note of caution, by asking whether the market exuberance was rational. Anothermethod makes use of the standard deviation from the long-term trend. To many Wall Street analysts, price appreciation of morethan two standard deviations from the long term trend is an indication of overvaluation.

The past, however, is not necessarily a good predictor of the future, especially when there is a paradigm or structural shift in theeconomy. Good understanding of past experience is, nonetheless, an important tool for evaluating the present and preparing forwhat is to come. Both the extreme values of price-earnings multiples and the standard deviations of past changes represent usefulbenchmarks drawn from past experience.

Another possible indicator is the reciprocal of current interest rates, or equivalently, the price of a perpetual bond.? Whenever theprice-earnings ratio of equities exceeds the price of the perpetual bond by a significant margin, there is a possibility of assetbubbles. This measure, however, assumes that the bond yield reflects the marginal rate of return?of an economy. In reality,however, policies of other countries, such as the low interest rate in Japan, may have a significant global impact. The prevailingdomestic interest rates may well be lower than warranted by local conditions due to capital flows. The low cost of fund can fuelspeculation and inflation in asset prices .

Chart 4 plots the perpetual bond prices (the reciprocal of current 3-month interbank rate) and the price-earnings ratio for the HongKong stock market. Note that:

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There appear to be three periods of irrational exuberance; first, 1979-1982, second, 1984-87; and third, mid-1996 to 3rdquarter 1997.

Prior to the fall in last October, the stock market prices were high relative to perpetual bond prices, although they weremodest compared to historical extreme values.

In fact, the P/E ratio of the Hang Seng Index, at 16.6x, when the index peaked in last August, was below the historical warningsignal of overvaluation (20x). Instead, overheating in the stock market was reflected by the unusually high P/E ratios of red chipsand H shares, which were at 52.3x and 30.3x respectively.

Property prices had also drifted above the level that is consistent with key economic variables, as shown in Annex 1. In the firstthree quarters of 1997, property prices increased by 43% year-on-year. Besides, Chart 5 shows that home prices as a multiple ofmedian household income in mid-1997 has exceeded the recent high of 1994. Although the housing affordability index remainsbelow that observed in the early 1980s, it was widely believed that house prices were becoming too high for many first time homebuyers.

Asset prices and the real economy

Economists would argue that causal links exist between asset prices and the real economy - via the wealth effect, whichinfluences consumption and investment . Rising equity prices, for instance, can boost shareholders?confidence and raise theirhousehold consumption. At the same time, higher equity prices lower the funding costs as more firms make use of equity financing,thereby increasing firms?investment in plant and equipment. Higher real estate prices have similar effects on households andstimulate housing construction. Conversely, once asset prices begin to decline, the reverse wealth effect causes disposableincome and profits to decline, leading to a fall in consumer expenditure and investment outlays. This relationship is neither linearnor simple, with complex leads and lags and uncertain transmission channels.

The relationship between asset prices and general inflation has not been stable. Very often, rising asset prices are not reflected in

higher prices for goods and services. Schinasi and Hargraves (1993), for example, found that, during the 1980s, much of excessliquidity was channeled to and recycled in asset markets, thereby reducing inflationary pressures on goods and services.

Using quarterly figures from Q1/1982 to Q4/1996, we conducted Granger causality tests to determine the links, if any, betweenasset prices, economic activity and inflation in Hong Kong (Annex 2). On the economy, we found that:

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Share prices do not appear to alter (in the Granger sense) real or nominal consumption significantly;

Share prices affect (in the Granger sense) real business investment in plant and machinery; and

Property prices have an influence on consumption.

Stock prices appear to have an impact mainly on business investment decisions, while property prices mainly influence householdconsumption. This result is consistent with the widespread property ownership by households in Hong Kong. (About half of thehouseholds own properties.) Household exposure to stocks is relatively small compared to properties . The wealth effect

generated by the stock market on mass retail consumption is insignificant. Charts 6A and 6B show the impact of changes inproperty prices on the real economy in the early 1980s and 1990s. During the property upcycle, there was a tendency for propertyowners to increase their consumption and to acquire more property on the expectation of further price increases.

In recent years, the impact of property prices on economic activity appears to be less obvious. As property prices deflated in theearly 1980s, there were three cases of bank failure and it took four years (1983 to 1986) for the building and construction slump torecover. At the trough, the value of private sector residential investment decreased 10.6% year-on-year in the March quarter of1984. By contrast, the banking sector remained robust during the period of asset price deflation in 1994/1995 and 1997/1998, andthe slowdown in construction in 1994/1995 lasted about 15 months.

On inflation, the direct relationship between home prices and CPI-A (all items) is less obvious. There is, however, high correlation

between home prices and general inflation as the housing sub-index of CPI(A) includes rental rates as a component (Chart 7). Wefound that property prices played a significant role in raising rental rates and the housing component of CPI(A). Again, the impactof asset prices on inflation was much greater in the 1980s than it is today (Charts 8 and 9).

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Policy considerations

One of principal objectives of the Hong Kong Monetary Authority (HKMA) is to maintain banking stability. Asset price inflation hasalways been an area of concern, since sharp asset declines would erode the collateral value of bank loans. As a number ofinternational experience has shown, the decline in asset prices has widespread contagion and deflationary effects. Thus, in theevent of a surge in asset prices, notably property prices, precautionary prudential measures are promptly taken.

When the expected rate of return on an asset exceeds the cost of funds, taking into account exchange rate changes, there will be


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excess demand for that asset. Inflated expectations of the return on assets can lead people to borrow aggressively. The resultingleverage plays a major factor in determining the level of asset demand and prices. Increased leverage also raises the probability oflosses and insolvency of the borrower and ultimately the safety of the banking system. Prudential guidelines are thus needed tomoderate the degree of leverage and asset price inflation.

Bank lending to the property sector is a crucial indicator. In the early 1980s, the rise in property prices was accompanied by theexpansion in bank credit to the sector. Property loans grew 34% in 1979 and 56% in 1980. In 1981, property prices collapsed,setting off panic reactions, withdrawals of loans, contraction of credit and business activity. Between 1983 and 1986, 7 banksfailed, including the third largest bank at the time.

In recent years, the HKMA has made the following prudential recommendations:

As a result, banks have been more prudent in their property lending. The growth of property loans has never exceeded 35% perannum since 1989 (Chart 10). At the peak of the property boom in early 1994 and mid-1997, the HK dollar loan-to-deposit ratiowas around 112%, compared with 135% in 1982.

Prudent banking practices paid off. Banks were little affected by the market downturns of 1994-95 and 1997-1998 when propertyprices fell by 20%-30% and the Hang Seng Index by 40%-50%. Mortgage loans are of high quality in Hong Kong. The ratio ofoutstanding mortgage loans to property value (assessed at loan origination or refinancing) averaged 52.0% as at end-September1997. Loan default rate is low at 0.1% of the total outstanding mortgage loans . Thus, notwithstanding corrections in the propertymarket, banks?exposure to credit loss in property loans is considered small. It is estimated that banks would not suffer any creditlosses on property loans made before the March quarter of 1997 unless prices drop below their level in the March quarter of 1994.

At the same time, the government maintains a tight fiscal policy . Moreover, the government is increasing the supply of land to

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slow the surge in property prices. In March 1994, March 1997 and July 1997, the government introduced detailed measures toimprove the flexibility of land use, land supply and to curb speculation in properties.

To demonstrate the government's resolve to tackle the property price problem through supply measures, the Chief Executive of theHKSAR set out three main targets in his maiden Policy Speech on 8 October 1997. The three targets include: to build at least85,000 flats a year in the public (55,000) and private (30,000) sectors, compared with 51,000 flats in 1996 (19,800 from privatedevelopment and 31,200 from the public sector); to raise home ownership rate from 50% to 70% in ten years; and to reduce theaverage waiting time for public rental housing from seven to three years.

The key to achieve these targets is to ensure a steady land supply and a high degree of predictability that supply will besustained. This involves the announcement in advance of a well defined, rolling five year land disposal programme against alonger ten year planning horizon. The HKSAR government plans to offer 378 hectares of land for auction in the coming five years,compared with 145 hectares in the last f ive years.

Coupled with these measures is a radical reform of planning and co-ordination functions within the Government which aims tostreamline various government planning, land and building approval processes for residential development.

Lessons learnt

Hong Kong experienced several asset bubble cycles in the past two decades. The use of leverage in speculative asset purchases

has played a key role in these fluctuations. Competition among banks, in particular, led to excessive property lending in the early1980s. The bursting of bubbles in the early 1980s produced bank insolvencies, and a deep slump in the building and constructionindustry. However, the authorities have since stepped up the monitoring and supervision of bank lending, particularly in theproperty sector. The prudential measures adopted, including benchmarks on loan growth, on property exposure and the ceiling forthe loan-to-value ratio, have ensured that banks remain safe and sound amid increasing competition.

In Hong Kong, escalation of property prices has played a key role in raising rents and consumer-price inflation. Share prices donot affect consumption prices directly, but contribute to inflationary pressure by raising aggregate demand through businessinvestment.

But inflation in asset prices can occur without a significant rise in consumer prices. The relationship between consumer-priceinflation and asset prices is complex. Excess liquidity can spill over to asset price speculation without an immediate impact onconsumer inflation. To focus on consumer-price inflation alone is to discard much of the information available for policy purposes.

In the wake of the potential adverse impact of the formation and bursting of asset price bubbles on the banking system and theeconomy as a whole, it is imperative for policymakers to detect early signs of bubbles. There are many ways to detect assetbubbles. A simple way is to check asset valuation against extreme values from the past, such as the peak price-earnings ratio forequity or rental yield behaviour for properties. Another way would be to compare current asset valuation to the current price of aperpetual bond?or the reciprocal of a key current interest rate. Many analysts rely on statistical procedures: Bubble alerts aretriggered when asset prices rise by more than 2 standard deviations.

In the absence of an autonomous interest rate policy within the framework of the linked exchange rate system in Hong Kong, assetprice bubble containment requires means other than traditional monetary and banking policy. To this end, the HKSAR Governmenthas recently embarked on policy measures that aim to relax supply-side constraints in the property market. The more flexiblesupply of housing, together with a reduction in the lead time in planning procedures, are expected to moderate price fluctuations inthe property market.

Annex 1: Model of asset prices

The stock market

We look at the relationship between the price-earnings ratio of the Hang Seng Index and market liquidity and interest rates. Theregression equation reads:


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PER = a + bFREEL + cINT + e

where:PER is the price/earnings ratio of the Hang Seng Index;FREEL, free liquidity;INT, 3-month interbank rate; ande, the statistical error term.

Two observations can be made on the outcome of the regression. First, excess liquidity in the financial system leads to higher

PER. Thus, b?in the regression equation should have a positive value. Second, PER expands as interest rates decline, since HKdollar deposits become less attractive relative to equities. Lower rates will also boost corporate profitability. The coefficient c?therefore, is expected to be negative.

These theoretical observations are supported by the regression results, which are as follows:

PER = 13.87 + 4.51FREEL - 0.64INT

(t = 2.00) (t = -5.91)

R-square: 0.76Durban-Watson: 1.27Degree of freedom: 58

The results show a high correlation between PER, free liquidity and interest rates. Chart 11 depicts the actual PER of the HongKong stock market against the PER predicted by the model.

This simple model hardly captures the full complexity of investment valuation by investors or of the vast amount of informationavailable in the market. Nor does the model explain the shifting, and often irrational, market sentiments. In fact, a large part of thedifference between the observed PER and the predicted PER is due to this short-term enthusiasm or pessimism. For example, themarket surge in 1987 and 1993 was not adequately explained by economic fundamentals. That portion of the PER expansion maybe regarded as irrational exuberance.

The property market

In our equation, property prices are a function of CPI(A), free liquidity, real best lending rate, and the ratio of real GDP to property


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stock. The regression equation reads:

P = F(CPI, FREEL, RBLR, GDPH) + e

where: CPI is CPI(A);FREEL, free liquidity;RBLR, real best lending rate;GDPH, real GDP divided by the property stock, and

e, the statistical error term.

Prices of tangible assets such as property move broadly in line with inflation and are inversely related to real interest rates.Liquidity is a supportive factor. The ratio of real GDP to the property stock is a measure of the balance between the forces ofdemand and supply in the housing market. We expect this variable to have a positive impact.

The regression results show:

P = -16.32 + 0.05CPI + 0.52FREEL - 0.08RBLR + 4.64GDPH

(t = 0.33) (t = 2.40) (t = -2.86) (t = 8.18)

R-square: 0.84Durban-Watson: 0.93Degree of freedom: 56

Chart 12 shows large overvaluation in 1991-1992 and 1994-95. Prices also appeared higher than warranted in the March quarterof 1997, although the gap between the actual and the predicted prices is not as wide as in previous episodes.

Annex 2

Tables 3a and 3b show the results of the Granger causality tests on the real economy and inflation. They are:


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References

Andersen, P. and W. R. White (1996) The Macroeconomic Effects of Financial Sector Reforms: An Overview of IndustrialCountries? Bank for International Settlements, Basle. January.

Bank of Japan (1996) Changes in the Corporate Balance-Sheet Structure since 1980 in Japan? Bank ofJapan Quarterly Bulletin, November.

Bank for International Settlements, Annual Report, 1993, 1994, & 1995, Basle.


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Baumgartner, U. and G. Meredith (1995) Saving Behavior and the Asset Price Bubble?in Japan? IMF Occasional Paper, No 124,April.

Bore, CEO, N. Kennedy, and SD Prowess (1994) Exploring Aggregate Price Fluctuations Across Countries: Measurement,Determinants and Monetary Policy Implications?BIS Economic Papers, No 40, April, Basle.

Brendan, F.J. and M. Joyce (1993) House Prices, Arrears and Possessions: A Three Equation Model for the UK? Bank of EnglandWorking Paper No. 14, June.

Buckberg, E. (1996) Institutional Investors and Asset Pricing in Emerging Markets? IMF Working Paper, January.

Cutler, J. (1995) The Housing Market and The Economy? Bank of England Quarterly Bulletin, August.

Financial System Research Council (1995) Interim Report by the Financial System Stabilisation Committee, Ministry of Finance,Japan, September.

Goodhart, C.A.E. (1995) Price Stability and Financial Fragility?in The Central Bank and the Financial System, MIT Press.

Hong Kong Monetary Authority (1997) Asset Prices in EMEAP Economies? a paper presented at the 13th EMEAP Deputies'Meeting, 21 March 1997, Hong Kong.

Hutchison, M.M. (1994) Asset Price Fluctuations in Japan: What Role for Monetary Policy? Monetary and Economic Studies,Volume 12, No. 2, December.

International Monetary Fund (1993-1996) International Capital Markets, Washington DC.

Ito, T. and T. Iwaisako (1995) Explaining Asset Bubble in Japan? National Bureau of Economic Research Working Paper 5358.

Japan, Ministry of Finance, Institute of Fiscal and Monetary Policy (1993) T he Mechanism and Economic Effects of Asset PriceFluctuations, Report of the Research Committee, April.

Kahkonen, J. (1995) Movements in Asset Prices Since the Mid-1980s? in Baumgartner, U. and G. Meredith.

Kindleberger, C.P. (1995) Asset Inflation and Monetary Policy? BNL Quarterly Review, March.

Mishkin, F.S. (1996) The Channels of Monetary Transmission: Lessons for Monetary Policy? National Bureau of EconomicResearch Working Paper 5464

Nakajima, Z. and H. Taguchi (1995) Towards a More Stable Financial Framework: Long-Term Alternatives - An Overview ofRecent Bank Disruption Worldwide? in K. Sawamoto, Z. Nakajima, and H. Taguchi (eds.) Financial Stability in a ChangingEnvironment. Basingstoke, Macmillan, p. 41-98.

Noguchi, Y. (1993) Asset Price Inflation and Economic Policies? Hitotsubashi Journal Economics, No 34, April.

Schinasi, G.J. and M. Hargraves (1993) Boom and Bust in Asset markets in the 1980s: Cause and Consequences,?in StaffStudies for the World Economic Outlook, IMF, December.

FOOTNOTE

1 The article is mainly the work of Yik-ko Mo of the Economics Division and Chad Leechor, former Head, Economics Division,Hong Kong Monetary Authority. An earlier version of this paper was prepared for the EMEAP Deputies Meeting in March 1997.

2 See, for example, Schinasi and Hargraves (1993) and Mishkin (1996)

3 See, for example, Baumgartner and Meredith (1995)


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2011 Hong Kong Monetary Authority. All rights reserved.

4 See, for example, Ito and Iwaisako (1996)

5 According to the Members Transaction Survey (1996) by the Hong Kong Stock Exchange, overseas investors contributed about32% of the market turnover between October 1995 to September 1996.

6 In other words, whenever the nominal cost of borrowing is lower than the expected rate of return on an asset, it pays aspeculator to borrow to purchase such assets, increasing the demand for such assets for speculative purposes.

7 see, for instance, Noguchi (1993) as well as Baumgartner and Meredith (1995)

8 The Members Transaction Survey (1996) by the Hong Kong Stock Exchange reported that during October 1995 to September1996, an estimated 34% of local individuals participated in the Hong Kong stock market.

9 Results of the Survey on Residential Mortgage Market conducted by the HKMA in Sept. 1997.

10 In the past 10 fiscal years, there was only one year (1994/95) which recorded a small fiscal deficit.


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HKMA - Asset Pricing and Central Bank Policies