Non-linear causality between the stock and real estate markets of Western European countries: Evidence from rank tests

a r t i c l e i n f o JEL classification: C22 E44 G11 Keywords: Causality Rank test Threshold error-correction model (TECM) Wealth effect Credit price effect Using the non-parametric rank tests proposed by Breitung (2001), we set out in this study to determine whether any non-linear long-run equilibrium relationship exists between the stock and real estate markets of Western European countries. We go on to adopt the threshold error-correction model (TECM) to determine whether a similar relationship is discernible possibly non-linear functions of the log-price of these two markets. The findings clearly point to the existence of long-run unidirectional and bidirectional causality between the real estate market and the stock market in regions both above and below the threshold level. Finally, we find the existence of both wealth and credit price effects in the real estate markets and stock markets of Western European countries, which thereby offer financial institutions and individual investors in their construction of long-term investment portfolios within these two asset markets. It has been clearly demonstrated within the prior literature that any attempt at precisely determining the relationship between the stock market and the real estate market remains somewhat contentious; and indeed, regardless of whether this relationship is examined over the short-term or the long-term, it remains unsettled as to whether the two markets are segmented or integrated. Of special interest to anyone observing the fluctuations are stock and real estate markets. For investors, whilst the growth of stock market alliances and mergers within the European Union signals increased institutional integration in European capital markets, there has also been growing interest in the implications of this process for investment decisions and strategies. Where consequences are identified for the level and pattern of business and investment activity, there will also be significant effects on the level and pattern of real estate performance. The massive fluctuations that are discernible in European asset prices have often been considered to be a boom and subsequent bursting of the bubble (boom and bust cycle); however, in the second half of the current decade, a much bigger boom–bust cycle has been experienced by the asset markets of Europe (primarily the stock and real estate markets) than by any other sector of the economy. Not only do these tremendous shifts in asset prices have a huge impact on the net worth of property assets, but they also have significant and persistent …