Demographics and asset prices in Australia: Do the dynamics of population ageing matter?

Abstract

The effects of population ageing on asset markets are complex. Recent literature has raised concerns of significant downward pressure on asset prices, housing and financial, due to the rapid demographic transition associated with retiring Baby Boomers. Awareness of this demographic transition and speculation over the consequent effects on asset markets prompted the asset meltdown debate. This thesis contributes to the asset meltdown debate and addresses the question whether demographic transitions, particularly the increasing proportion of the population in the old age cohort due to the retirement of Baby Boomers, will precipitate a dramatic decline in house and stock price in Australia. The structural vector autoregressive model used for the empirical analysis is an important improvement over the reduced-form regression strategies usually employed in the literature. Both the demographic and non-demographic variables used in the empirical analysis are treated as endogenous and reverse causality between the variables is taken into account. The population ageing dynamics are modelled using impulse response functions and, thus, an insight into the potential magnitude of demographic shocks, particularly retirement shocks, is obtained. The analysis quantifies the responses in real house and stock prices to such shocks. The structural shocks are characterised as a sequence of shocks, often with different signs at different points in time, rather than one-off shock. The cumulative effect of such a sequence of shocks on the evolution of real house and stock prices over time is examined using historical decomposition. In addition, the forecast error variance decomposition is used to quantify the percentage contribution of the total variation in real house and stock prices to each structural shock in the models for different forecast periods. The findings support the optimists’ view in the asset meltdown debate. Predictions that population ageing, or more specifically, changes in age structure particularly due to retiring Baby Boomers, will lead to pronounced downward pressure on real house or real stock price in Australia are rejected. The findings suggest that Baby Boomers are unlikely to sell enough housing and financial assets in retirement to precipitate a market meltdown, or a sudden and sharp decline in real house or stock prices. With the benefit of hindsight, we also see that the one fourth of the Baby Boomers are already retired and the Australian housing market and stock market does not show signs of collapse or substantial price decreases. Poterba (2001) provides a possible explanation for these findings, namely, even though changes in age structure affect asset demand, these effects are simply too small to be detected among the other shocks to house and stock prices. Moreover, the anomaly as revealed by asset ownership statistics, that the older population cohort continues to hold or accumulate assets rather than de-accumulate as originally predicted by the life cycle hypothesis sheds light on why population ageing does not exert a pronounced downward pressure on asset prices in Australia.