Dynamic Co-movements between Economic Policy Uncertainty and Housing Market Returns

Executive SummaryThe financial crisis that followed the meltdown of the U.S. subprime mortgage market and the subsequent Great Recession were characterized by exceptionally large falls in house prices, as well as unprecedented levels of economic uncertainty. Against this background, we examine dynamic correlations between housing market returns and the economic policy uncertainty (EPU) index developed by Baker, Bloom, and Davis (2012), controlling for economic and financial fundamentals. We find negative correlations throughout the 1987–2014 period. More importantly, correlations are time-varying and tend to increase sharply in times of high economic uncertainty, notably around U.S. recessions. This implies that tail risks, or the probability of unusually large losses for investors in real estate and related securities following spikes in uncertainty, are significant.