Information asymmetry in the first- and second-hand housing market

Abstract

This thesis examines how heterogeneous traders could behave to reduce information asymmetry with the buyer knowing less than the seller. Akerlof's seminal paper (1970) predicts that lower quality goods (lemons) will drive out higher quality goods (peaches) under information asymmetry. Subsequent studies mainly focused on testing the validity of this prediction and various counteractions that could arise to counteract the effects of information asymmetry. Without exception, these studies (implicitly) assume that traders are homogeneous. In this thesis, we relax the homogeneous trader assumption and conjecture that markets for lemons and peaches can co-exist due to (1) variation in the cost of reducing information asymmetry amongst buyers, and/or (2) variation in seller's capability to reduce information asymmetry. The influx of non-local buyers into the housing market in Hong Kong in recent years provides a good opportunity for a natural experiment to test the above conjecture since the buyers and sellers are heterogeneous and can easily be differentiated from each other. The information asymmetry problem is serious in Hong Kong's housing market due to the dominance of multiple ownership apartments. In a multiple ownership building, the quality of a housing unit is affected by the quality of the adjacent units. This makes it difficult to reduce the information asymmetry problem by seller's warranties or hiring an expert to ascertain quality in the second-hand market. Only in the first-hand market can the seller (developer) who is also the single owner provide warranty during the defect liability period. In addition, some large developers have successfully established goodwill to signal the quality, since for them, real estate development is a repeat business. Non-local housing buyers, impaired by their distance from the housing unit they want to buy, are recognized as being less informed buyers in the market since their search cost is a lot higher than that of the local buyers. The influx of non- local buyers in recent years has increased the proportion of less informed buyers. In the absence of experts to assess quality in the second-hand market, non-local buyer's cost of reducing information asymmetry becomes prohibitively high under most circumstances. They would rather spend more money to outbid local buyers in the first-hand market than to spend time and resources to reduce information asymmetry in the second-hand market. Using transaction data from 1995 to 2015 in the Hong Kong housing market, we find evidence consistent with the implications of our conjecture. Results from our Logit regressions suggest that, holding other factors constant, non-local buyers are more likely to purchase in the first-hand market than in the second- hand market. This inclination becomes weaker when the information asymmetry problem is less serious in the second-hand market, which includes purchasing housing units with higher land leverage, built by reputable developer, or owned by non-local sellers. Our empirical results show that non-local buyers paid, on average, 4.3% more than local buyers in the second-hand market, which is double of that in the first- hand market. Sellers in the first-hand market could fetch, on average, 5% more than those in the second-hand market could, after controlling for the possible effects of other factors. This difference is smaller in more expensive locations (higher land leverage) and for units developed by reputable firms. These results contribute to our understanding of the role of information asymmetry in shaping the behavior of heterogeneous buyers and sellers, particularly in the absence of experts to ascertain the quality.