SMU Office of Research – At the mention of finance our minds fill with images of corporate suits, glass towers or data flashing across screens. But we would do just as well to think of families sitting around kitchen tables littered with real estate flyers and hardware store promotions. Decisions made in the family boardroom, when aggregated across neighbourhoods, cities and states, can make or break an economy.
One only has to think of the mortgage market crumble that precipitated the 2008 financial crisis to see that, just as history is about much more than the deeds of great men, academics need to look beyond Wall Street to test their principles and models.
Assistant Professor of Finance Choi Hyun-Soo of the Singapore Management University (SMU) Lee Kong Chian School of Business is one such researcher who is delving into the data behind thousands of household financial decisions. His most recent research examines the reasons why families choose real estate over the stock market.
A local bias effect
In his working paper, tentatively titled “When Real Estate is the Only Game in Town”, Professor Choi examines the reasons behind a population’s collective penchant for real estate investments and the implications of this for an economy.
A lot of it may have to do with a phenomenon called ‘local bias’, his research shows. This previously identified behaviour sees investors preferring stocks in companies that are headquartered near to where they live, because they feel they are better informed about the company. “People living in a city like New York are more likely to invest there, even within a 20 kilometre radius—it’s a well-known bias,” he explains.
Professor Choi and his colleagues took this concept further by comparing investment decisions by families living in metropolitan statistical areas with many or few public company headquarters. Through studying thousands of investment decisions across the US, they found that people living far from public company headquarters were more likely to invest in real estate than stocks—even though the stock market is borderless.
The local bias effect on investment decisions has important implications for regions with underdeveloped stock markets, Professor Choi argues. “The biggest sufferers in the financial crisis were cities like Miami, Las Vegas and Phoenix, where households had put their faith in local real estate rather than invest in companies located far away from them.”
While the research is based on US data, Professor Choi says the findings raise important questions in Asia’s context. “Places like Singapore and Seoul have had huge real estate booms as well as relatively less well-functioning stock markets.” The implication is that cities in this position might have too many proverbial eggs in one basket.
Hammering home the advantage
When a property bubble blooms, the sounds of hammers and power-saws start ringing throughout the suburbs like the awakening of cicadas in summer. Previous thinking suggested that such booms in DIY spending was tied to the looser financial discipline that comes with rising house prices. But Professor Choi’s research found that householders should be given more credit than this.
Using data about the costs and recoup values of remodelling projects across US cities, his research found that when house prices increase, homeowners become optimistic about future prices and so speculate by improving their homes with a view to making a better return if they sell their home.
This behaviour, described in his 2014 paper “Speculating on Home Improvements” published in the Journal of Financial Economics, makes good financial sense, says Professor Choi.
“During average economic periods, home improvement is purely consumption—in fact it only returns about 70 percent on the amount spent,” he explains. “But during a real estate bubble, home improvement becomes an investment. People tend to get back more than they spend, especially for improvements on kitchens and bathrooms.”
While this suggests that the family boardroom can produce good decisions, the interaction between households and financial institutions continues to fascinate Professor Choi.
Despite a regulated financial market which has built-in consumer protections for the increasingly savvy and educated investor, Professor Choi stills sees the potential for an ever-evolving game between financial institutions and their clients, which could again see household behaviour driving negative financial market trends.
“Consumers are continually learning financial literacy and becoming more sophisticated. They make initial mistakes and then they learn,” Professor Choi notes. “But the speed of learning may not be fast enough to keep up with the growing complexity in financial products.”
By David Turner