Crise Imobiliaria Dubai

University of Amsterdam

Master Thesis

Empirical Analysis

of the Forming of Art Bubbles in China

Xingkui Wei 6262252

Amsterdam, 14 July 2011

dr.D.A.SalzmanFaculty of Economics and BusinessUniversity of Amsterdam

Master Thesis Xingkui Wei 6262252

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TABLE OF CONTENTS

SUMMARY .....................................................................................................................................3

1 INTRODUCTION........................................................................................................................4

2 LITERATURE REVIEW............................................................................................................6

The concept of bubble economy.............................................................................................6

The test models of bubble .......................................................................................................6

The studies on art market.......................................................................................................8

3 RESEARCH DESIGN AND METHOD...................................................................................10

Data collection .......................................................................................................................10

Research setting.....................................................................................................................10

Data analysis..........................................................................................................................12

Limitations.............................................................................................................................13

4 THEORETICAL FRAMEWORKS AND RESEARCH BACKGROUND...........................14

Asset bubble and bubble asset .............................................................................................14

Economic bubble and bubble economy...............................................................................15

Changing rules of asset bubble ............................................................................................15

Research background ...........................................................................................................16

Japan bubble economy .........................................................................................................17

5 THE APPLICATION OF MODELS AND FINDINGS ..........................................................20

The chose of influencing factors...........................................................................................20

The analysis of influencing factors and findings ................................................................21

The research of art bubbles and findings............................................................................27

6 GLOBAL ART INVESTMENT FUNDS..................................................................................31

The risks of art investment...................................................................................................31

The normal ways to mitigate risks.......................................................................................32

International art funds cases................................................................................................33

7 DISCUSSION AND CONCLUSION........................................................................................37

8 BIBLOGRAPHY........................................................................................................................39

9 REFERENCE.............................................................................................................................42

10 APPENDIXES ..........................................................................................................................44


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SUMMARY

The uprising of Chinese art auction market in latest years draws the attention of all kinds of

investors. One of the intense questions that make the investors as well as government worry about

is the reason of the forming of art bubbles in china, which influences the trends of the prices of

artworks and the risk of investment. I attempted to solve this problem by applying the bubble

economic model in the studying of the forming mechanism of art bubbles in china. I do hope to

bring some understanding of the definition of bubble economics on the view of art and try to

explain explicitly the elements to formation of the bubbles. I find that the market situation and

economic background have a deep influence on the prices of artworks. No matter in china or in

Japan, the economic bubbles were forming with the up surging of inflation rate, the booming of

real estate market and the appreciation of domestic currency. I made a regression model to find out

the main reasons for the rise of art prices, and I found that the wealth asset, transaction sum in art

auction market and CPI impact mostly on the prices of art works. And I found that the art bubble

in Chinese mainland market is not that significant, while it is very outstanding in the Hong Kong

area.

Key words: art bubble, bubble economic model, financial crisis, intrinsic value, art investment

funds, risk management


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1 INTRODUCTION

Financial crisis damped down the enthusiasm of investment in stock market and manufacturing

industry, severe real regulation on estate market makes investors in china step back. However, a

big trend of investment in art has showed up since 2008 with four Chinese modern paintings

which are more than one hundred million RMB respectively in the auction market. Financial

institutions, syndicates, as well as individual investors such as coal bosses show high positiveness

in all kinds of art auctions which is contrast to the intense financial budget under financial crisis.

Lately, there was about 100 billion RMB hot money flow into Chinese art market, which came

from Wenzhou syndicate in china. Every auction could gain more than hundred million or even

billions RMB, and 50 to 80 percent of them are venture capital (Wu, D, 2010).

This phenomenon was discussed by so many economists as a bubble economy. Indeed, as Jing,Z

(2007) , who is the deputy secretary general of Chinese collector association , says, the average

return on investment in financial securities is 15%, in real estate is 21%, but in art market, it is

outstandingly 30%. In history, china has had three times of collecting booms, which were during

the late Northern Song Dynasty, Tang Dynasty, and the late Qing Dynasty1, the art bubble now in

china is regarded as the fourth collecting booms with its outstanding feature that the over 90

million of collectors cover all kinds of occupations, religions, ages and so on. (Jing, Z, 2007).

Such large scale of market makes the price of Chinese artworks raise substantially. According to

AAMI (Atron Art Market Index), in 2010 the 100 index of tradition Chinese painting, oil painting,

modern painting, and contemporary painting has raised by 40% in one decade. When the price is

greatly diverging from the intrinsic value we call it economic bubble. As some economists

observed, the high price and high volume has formed art bubble in china. Just as Vikram

Mansharamani (2011) reported in his article The Next Art Bubble: a delicate pear-shaped

Chinese vase was the star of the week, skyrocketing past its pre-sale estimate of $800 to $1,200 to

sell for more than $18 millionIt reflects a national overconfidence that has been a consistent

ingredient in financial bubbles. Certainly, there was a bubble and everybody thought it might

take a couple more years for it to burst, but the crisis brought it on, so there's going to be a big

shake-up in the industry, Brian Wallace (2011), director of Red Gate2, said.

Most of Them think its because the slump of stock market and real estate market drives the hot

money to the art market. So why is the art bubble forming during the financial crisis, whats form

the intrinsic value of artworks, and if it is really a bubble economy, what can we do to control the

investment risk .In this thesis, I will analyze the reason of art bubble in china according to the

bubble economy theory and empirical research. Especially, I will compare the situation of china

on nowadays with the situation of Japan during 1985-1990, and then use real data to find out the

main elements of bubble economy which generated the art bubble in china. On the other hand, I

1 The Northern Song Dynasty started from 960 to 1127, the Tang Dynasty was from 618 to 907, and the Qing Dynasty was from 1644 to 1911.2 Red Gate Gallery is an international artists residency program providing artists, curators, writers, and academics with the opportunity to live and create work in China.


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will summarize the global art investment funds to figure out the risk control method by investment

funds. Such a study should give insight into the practical investing environment in art market in

china, and give a guideline of investing ways; also, the study will provide some methods of risk

management in art market.

The paper is organized as follows: First, I discuss the conceptual framework of bubble economy,

including asset bubble and bubble economy, especially in the scope of art. Then I explain the

situation of Chinas art auction market at present and compare it to the Japans before the burst of

economic bubble. Next, based on the study of the condition of chinas art market, I can present the

reasons to the forming of art bubbles in china. Afterwards, I present the research methodology and

the real data that I employed to study the main factors of the forming of art bubbles as well as the

existence of art bubbles. Finally, I will introduce some cases of the art investment funds in Europe,

American as well as Asia to provide a reference to the creation of art investment funds in china.


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2 LITERATURE REVIEW

In this section, I will review the literatures about the concept of bubble economy, the existing

methodology for the study of bubble economy, and the study on the art market.

The concept of bubble economy

Bubble is the most fundamental concept in the study of bubble economy, but theres no

acknowledged one up to now. There are some of the representativeness concepts as bellow:

Charles P.Kindleberger (1978, p. 16) defined a bubble as "an upward price movement over an

extended range and then implodes" and this definition is neutral. According to Kindleberger,

bubble is a process from generating to burst. It is overvalued investments that impel the forming of

bubble. Yoshio Suzuki (1998), a Japanese scholar thought that the bubble in economics is the

prices of land or goods rise or fall dramatically without any fundamental conditions. From the

view of Suzuki, bubble is relative to the condition of fundamental economy, what we need to think

clearly are what is and how to confirm the condition of fundamental economy. The basic idea of

Burmeister, Flood, and Garber (1983) is that a bubble is an extra component that arises in addition

to the component that reflects market fundamentals, which means the bubble components are

not easy to burst. Diba and Grossman (1988) described rational bubble as the price that apart from

the intrinsic value, it is nonnegative and Continuous expansion. Garber (2000, p. 4) defines a

bubble as the part of the price movement that cannot be explained by fundamentals. A definition of

bubble described by Chinese scholar Y, Dai (2001) is bubble is an economic phenomenon, namely

in a continuous process, the prices of an asset or a group of asset raise sharply, which induce the

investors to make a prediction of the further rise of prices, thus attract new investors. Their

purpose of trading is gaining profit through transaction, instead of using it. According to this

definition, investors should be speculators. Another definition is offered by Barlevy (2007) who

describes a bubble as a situation where an assets price exceeds the fundamental value of the

asset. Economist and Princeton professor Brunnermeier(2009) describes that bubbles refer to

asset prices that exceed an assets fundamental value because current owners believe that they can

resell the asset at an even higher price in the future. He further states that bubbles are typically

associated with dramatic asset price increases followed by a collapse.

The test models of bubble

Variance bounds tests

Shiller (1979) and LeRoy & Porter (1981) created the earliest econometric model for the detection

of bubble. The creation and use of this model was based on the present value model of stock prices,

i.e. stock prices should equal the value of expected dividends. As a matter of fact, variance bounds

test were not originally designed to test the economic bubble but rather to test the efficient market


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hypothesis and the present value model. Blanchard & Watson were the first researcher who

indicated that it could be used for the purpose of bubble identification. To explain the general idea

of variance bounds tests, I provide Shillers (1981) newer variance bounds test model as a

example. Shiller examined if the variance of dividends can explain the variance of stock market

prices by comparing the variance of the market price with the variance of the ex post rational price.

According to Shiller, the actual stock prices reflect the value of the estimated future dividends

applying the efficient market model. However, if the variance of the actual stock market prices is

more volatile comparing to the variance of the ex post rational price, the variance bound is violated.

Dida & Grossmans (1988) Bubble Test

The test model examines the dividends and stock prices by analyzing the stationary features of the

stock prices and their fundamentals. The bubble test model consists of the dividend payments, the

current stock price, the present value of next periods expected stock price, and an unobservable

variable. In the empirical testing of Diba and Crossman, they applied the dataset published by

Kleidon (1980) to analyze the autocorrelation model. It was suggested in the test that explosive

rational bubble do not exist in stock prices. However, Grkaynak (2008) pointed out that there

were some problems in the econometric analysis of stationary propertieswhich would result in contradicting results. Furthermore, he argued about the assumption of stationary of the

unobservable variable, as it may not hold under certain circumstances. In addition, Evans(1991)

disagree with the conclusion of Diba and Grossman that explosive rational bubble do not exist in

stock prices. He thought that bubbles might pop up, collapse and restart (periodically collapsing

bubbles). Because the tests model that used by Diba and Grossman can only be successfully

applied when bubbles last for most of the period observed, thus these tests are not appropriate in

testing the periodically collapsing bubbles. As the test bases on the stationary properties of the

stock prices and the dividends, it needs to be applied over a long period of time.

Froot & obstfelds (1991) bubble test

Whats new in Froot and Obstfelds study is that they make a distinction between rational bubbles

and intrinsic bubbles. The intrinsic bubbles follow endogenous economic factors, while rational

bubble was caused by extraneous economic factors. In their analysis, a model based on

endogenous economic factors can better explain the fluctuation of stock prices. The main idea of

their model is the assumption of a nonlinear relationship between fundamentals and stock prices.

Changes of fundamentals and a non-stationary price/dividend ratio would lead to the overreaction

in stock prices. In the empirical testing, they used Standard and Poors stock price and dividend

indexes from the security price index record over the period 1900-1988. They proved that there is

an overreaction in stock prices from changes in dividends, moreover, they explain in their model

that why the stock prices fluctuate so much and not declined along with the decrease of the

volatility of dividend.

Ges model

The econometric model which I used to analyze the impacted factors of the art bubble in china and


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the testing model for the level of bubble will be guided most generally by the research of bubble

economic theory and model by Ge Xinquan in 2005.The research focuses on the intrinsic

mechanism of bubble economy, and the model of bubble economy including CAPM, Fama and

French Model, stock pricing model, inspection, judgment and control methods. As his study

covered the empirical research on the shanghai stock exchange market, as well as Japan and

American stock markets, thus the instruction function of this book is very considerable. I will use

the theoretical and practical methods as a core model for my research.

The studies on art market

The article Vested interest and biased price estimates: evidence from an auction market by

Jianping Mei and Michael A. Moses indicates a relationship between auctioneer presale price

estimates and the long-term performance of artworks. They investigated the art auctions and

collected data over 5,500 pairs of transactions between 1875 and 2002, employing two

asset-pricing models to control for the difference in risks of artworks when measuring abnormal

returns. As a result they found that high estimates at the time of purchase are combined with

adverse abnormal returns. This article gives me an important thought of the impacting factors for

the art bubble in china, and also provides me a reference for the calculation of abnormal return.

The reference of my research also includes another article by Jianping Mei and Michael Moses,

which is Art as an investment and the underperformance of masterpieces. In this article, they

construct a data set of repeated sales of artworks and estimate an annual index of art prices during

1875-2000 in order to prove that the masterpieces are underperformance in the art market. The

new thought of them is the price growth index is based on the repeated sales of artworks thus they

can get a real growth rate of the transaction price. The evidence of underperformance of

masterpieces is also achieved by the repeated sales regression. In My testing model for the level of

art bubble in china, I would like to consider the underperformance of masterpiece in Chinese

auction market.

As my study would refer to the Japan bubble economy to analyze the forming of art bubble in

china, I acquire some of ideas from the article How did Japanese investments influence

international art prices, which was conducted by Takato Hiraki et al. They found that there are

some relationship among the art, Japanese land, Japanese and U.S. stock market. Although the

impact of land prices on art prices didnt show up before the burst of bubbles, it did emerge after

the burst of bubbles as the decreasing land prices in Japan urged some Japanese investors to sell

their holdings of arts at a considerable bargain. Their data handling methods give me an example

for the analysis of the relationship between the house as well as stock prices and the artworks

prices in china.

With the purpose of compare the situation of china with that of Japans during the bubble economy,

I get a keen cognition of Japanese economy by the book The Bubble Economy: Japan's

Extraordinary Speculative Boom of the '80s and the Dramatic Bust of the '90s from Christopher

Wood. In his book he presented the sources of bubbles in Japan from different aspects of financial

institutes such as banks, life insurance companies, securities companies, and brokers and so on. In


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his narrative, the scandals existed in all kinds of fields and ways, bureaucrats and politicians are

the manipulators of this game. This book also reveals how Japan was spending the first half of the

1990s paying off these excesses by different departments which threatened the world's economies.

It also questions many of the myths which were built up around Japanese management, indicating

the incompetence of managers who didnt think for the possibility before they invested.

As for the data I employed to build the bubble economic model, they are mostly come from the

Chinese art auction market survey reports by Artron art market monitoring center which is an

authoritative website for investors in art around the world. These reports contain the introduction

of art markets situation nowadays, the transaction volume, the price index of several kinds of

artworks, the performances of several auctions in different districts in china, and the statistics of

some hot artists total artworks in trading and the total transaction volume. According to the report,

the categories of artworks can be divided as Chinese painting and calligraphy, oil painting and

contemporary art, porcelain and other art ware. The price index includes oil painting 100 Index,

Chinese painting 400 Index, contemporary art 18 Index, realistic painting Index and so on. With

these data, I can fulfill my bubble economic model.

Apart from the methodology and data reference, I also conduct my research depending on some

updating articles online or on newspapers, for example, the article Chinese art market: an

investing opportunity of high rate of return(2009) gives me a good view of the latest situation of

the art market in China. The author interprets an uprising but still underestimated market,

including the talents of Chinese artists, the trends of home decoration art, the high return of

Chinese oil painting as well as the low return of masterpieces. The article from the art newspaper

Art reversion under financial crisis2009 focuses on the boom of Chinese contemporary paintings after the financial crisis, and compares it to the fluctuation situation of art market of

Japan and America after the financial crisis. At the same time the author give an idea about the art

bubble will burst in a short time because of the replicability of contemporary paintings. In a

lecture from the vice secretary general of China collector association, Jing zhizhong, he mentioned

the return rate of art market in china which is far more higher than the stock and real estate market,

at the same time , he talked about the feature of this collecting boom, which gives me an

authoritative data and outlook. Tao,Y(2010) specified the art investment fund around the world,

giving me a fundamental knowledge of art investment fund.


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3 RESEARCH DESIGN AND METHOD

Data collection

The previous section reveals the theoretical frameworks of bubble economy, the tests models as

well as the present studies on art market. But they did not explain why the bubbles form in the

financial crisis time, why the Chinese art auction market upraises suddenly in these years, and if

there are high risk in art market. By extensively studying the data in Chinese art market, I applied

a theoretical model to specify the reasons for the existing of bubbles. In my pursuit of answering

the questions I mentioned above, I observe the transaction records in a great deal of auction

markets in china. There are around 100 sample institutions used by Artron art center to collect

trading data and analyze the current situation of art market. They can be divided as five different

districts, Beijing district, Yangtze River delta district, Hong Kong, Macao and Taiwan district,

Pearl River Delta district, other district in china, and other district abroad. By dividing those

districts, I can easily get the shares of different area, thus learn the development situations of them.

The reason why I chose Artron art centers quarterly reports as my resource of data is because it is

the most complete and widely used data flat around the world. It collected the transaction records

which are relative to Chinese artworks from 212 auction companies across the world in 15 years.

There were around 4000 special auctions and more than 1.3 million image-text data in the data

base; moreover, it increases with 700 special auctions and 250,000 lots every year. In addition,

artron art center put more information about the worldwide auctions of Chinese artworks from

1970 in the data base to make it more complete. On the other hand, it updates 60,000 Chinese

artists detailed information everyday, as well as 1000 galleries and 600 art institutions yearly

exhibitions. With these data, Artron art center continue to do a deep analysis of the art auction

market in china, which starts with the Artron Art Market Index since 2004. They hope the index

could be used to analyze, statistic and predict the market, but not just store the transaction

information. In their research at present, there is more data analysis and prediction, but less

investing, financial, assessing and insurance advises, thus thats an aspect that Im going to add in

my research.

Research setting

This thesis is going to specify the following objectives:

First, the real reasons for the forming of art bubble in china. As most of the economists say, the

real reason is the slump of stock market and real estate market drive the hot money of those

venture investors to the art market to capture more profits and at the same time diversify the

investment portfolio to avoid too much risk. On the other hand, even under financial crisis, the

economic of china is still showing promising prospects, thus the GDP growth may impact the


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price of artworks. As the average wage growth in 2009 which was released by Chinese

government was 12%, will the growth of income be the reason of art bubble? If it isnt, dose the

increase of plutocrats income compose the reason of art bubble in china. In addition, Mei jianping,

who is one of the founders of Mei Moses Art Index, considered that the value of artwork is

affected by the artistic style, the fame of artists, and the quality of artworks. The preference of

certain kind of artworks around the world in different times may drive the price of artworks run up.

David Eubank (2011) posted in his article about Chinese art like this: The contemporary art being

produced by a wide variety of artists throughout China is fresh and exciting and the work by many

leaders in this new art movement is powerful and important. In one of Mei and Moses study,

they showed an opinion about the auctioneer estimates would be unbiased thus influence the price

of artworks. There are more factors for the forming of art bubble in china as the particularity of

Chinese market.

The second objective is to find out the core reasons for the forming of art bubble. On the basis of

all of the factors of art bubble mentioned above, I will use econometric model to find out three to

five core reasons, at the same time, compare them with the reasons for the Japans bubble

economy. With these elements I can try to predict the future trend of art market in china, and

analyze if it is a healthy market.

Thirdly, test the art market in china and measure if it is a real bubble. some of the economists say

that since the intrinsic values of Chinese artworks are much more higher than the values that have

been recognized by the collectors around the world, so the dramatically raise of price is a good

thing as the value of Chinese culture is finally appreciated by collectors. This is one of the points

that they use to against the view of art bubble. Its true that some of Chinese paintings are

undervalued in the world wide markets, however, there are still a lot of contemporary and modern

artworks are overvalued in the auction market as some experts can see. Thus the research of art

bubble in china can give investors a guide on art investment, and is good for the rational biding in

the auction.

Last but not the least, give an overview of global art investment funds. Even when we are living in

the bubble economy, we cant tell how and when the bubble will burst. Burst of bubble will incur

serious financial problem and lead to devaluation of asset thus result in recession in this industry

and even other industries. With this concern, the existence of art investment fund is aiming to

diversify the portfolio and increase the investment return of investors. How do the investments

funds operate in different countries, if they really realize what they promise to their clients or not,

what can we do to develop the art funds market in china? However, as we all know, capital

operation would quicken the forming and expansion of bubbles, so I would like to know if the

disadvantages of funds already outweigh the advantage of it. As we can see, after the burst of

Japans bubble economy, Japan went through a long period of downturn. Thus it can be seen, the

appropriate regulation and development of Chinese art investment funds is very important for the

stable and sound development of chinas art market.


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Data analysis

To achieve all of the objectives mentioned above, there are some approaches which explicitly

explain the works that will be done during my research.

To start with, I need the data of the capital flows of the art market during 2008 to 2010, which

come from the volume of transaction collected by Artron art market monitoring center. Also, I will

conduct the research with the GDP and wage statistic released by the National Bureau of Statistics

of China. Apart from this, the price growth rates of all kind of artworks could be acquired from the

Chinese art auction market survey report.

After all of the data are prepared, I can start to build the econometric model which refers to the

bubble economic model y=b0 + b1x1 + b2x2 + + bnxn. With this model, I will substitute those

data to do regression analysis and obtain the value of every b, deciding which reasons are the core

factors for the art bubble in china.

With these factors, I can continue to test if theres real bubble in the art market. As the art pricing

model is still under studying by some economists, such as Mei, J. and M. Moses, my research is

not that realistic to carry out by the art pricing model. Therefore, I would test the bubble by index

method such as income ration or growth ration. Moreover, I would use the bubble testing model

Sy

Sxjjj , in which j is the Standardized coefficient of the value of j in the

regression, j is the unstandardized coefficient, and Sxj and Sy are the expected standard deviation of explanatory variable and explained variable respectively. If the value of

j decrease while the volume of variables increase, the relationship between explanatory variable and explained variable is negative or it is not that significant, thus if the Sxj is the

standard deviation of wealth or the income of main investors in china, then the probability of

bubbles is exists. To measure the real growth rate of bubbles, I can apply the regression model to

get the equilibrium price of artworks and then compare it with the real price of artworks in the art

market, so that to get the bubbles value and its growth rate.

The last objective is to specify some cases of the global art investment funds and the lessons that I

can get from the real practice of these investment funds. As there werent substantial experiences

of the Chinese art investment funds, I will consult the practice of Japan and some western

countries as they have more successful precedents. However, Chinese market is more special in

this situation, such as the high speed of economic development, the very large Gini Coefficient,

the social formation, and political system, so I will consider the appropriate advises for the

improvement of chinas art investment funds.

After explaining all the methods I would use to pursuit my goal, I would like to talk about the

analysis of data.

In fact, analyzing data is the core procedure of extracting the creative insights from a lot of data

collection and models building. By analyzing data, I would get an empirical result from a


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theoretical way, through which I can examine the practical abilities of theories; moreover, I can get

a new idea from the existing knowledge. However, analyzing data is also the most difficult and

the least codified part of the process (Eisenhardt, 1989). In order to find out the reasons of the

forming of bubbles in Chinese art market, I would have to constructed the development history of

Chinese art auction market by documenting all of the data chronologically, including the trading

volumes every year, the Chinese GDP, the wealth of plutocrats, the prices of different styles of

painting, and the estimate of auctioneers. Additionally, I will make tables to facilitate the further

analysis of the elements that will influence the development of art market in china. I start my

analysis by studying the activities that contribute to the forming of art bubbles, such as all the data

that I mentioned above. Especially, I would consider about how all the changes of each kind of

data every year would carry out the development. After these analyses, my attention then turns to

the core reasons to the forming of bubbles in art market. Whats the importance of specifying the

core factors of the forming of bubbles is the magnitude of their coefficient. The risk of

investment in Chinese art could be identified by these core reasons, as if the quality of the

artworks is not the main element that contribute to the raise of prices, the collection of Chinese

artworks would be involved in a lot of risk. Even though there are definite factors of development,

most of the people are not sure that if bubbles are really existing in Chinese art market or not.

Thus I would introduce the testing model into my research. The testing methods include index

methods as well as calculation of Standardized coefficient of the value of coefficient from the

regression. According to the index method, I can measure the growth rate of every data, but as

theres no precise standard lines for the confirmation of bubbles, so it is hard for me to say that it

is bubble or not. Standardized coefficient could be better used in the testing procedure as it is easy

to make a conclusion.

Limitations

Even though the data base I used is considered as widely used and most complete data pool, there

are a lot of limitations of this study that I acknowledge. As the quarterly reports that I applied for

my study are started from 2008, at the same time, they just come from one art center, thus it is

often criticized as suffering from limited generalizability. My study has tried to compensate this by

enrich the background information of the present situation of Chinese art market. Moreover, the

existing theoretical criteria and the theoretical models are use for the empirical research in my

research, thus the new findings should be used to improve the existing bubble economic models.


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4 THEORETICAL FRAMEWORKS AND

RESEARCH BACKGROUND

In this section, I first present the theoretical frameworks of bubble economy including asset bubble

and bubble asset, economic bubbles and bubble economy, the changing rules of asset bubble.

Afterwards I discuss about the research background, i.e. the development situation of art auction

market in china nowadays.

Asset bubble and bubble asset

According to the existing literatures about the bubble economy, asset bubble is the fundamental of

bubble economy. Bubble is the part of price that exceeds the intrinsic value of an asset, which is

driven by the speculative expectancy. With the accelerating of speculative expectancy, the price

keep rising, thus the asset bubble changes from quantitatively to qualitatively, and then it will

become bubble asset. If the price of the asset still keeps going, the bubble will burst because of the

sudden reverse of expectation. To specify the nature of bubble, I have to indicate the following

points. First of all, as the asset would create bubbles, it means that the asset is not a normal asset,

but the rare asset that the owner thinks it will appreciate. Secondly, considering about the existing

study on bubble asset, people buying and holding a certain asset is not going to use it, but rather

gaining profits from the trading in market, which is a kind of speculation. Thirdly, the reason of

why the bubble is so difficult to test is because the intrinsic value of the asset is not easy to know,

we can only get it from building the asset pricing model with some relative information. Fourthly,

when the market price is higher than the intrinsic value, the bubble is positive bubble; otherwise, it

would be negative bubble. Some researcher said the positive bubble and negative bubble exist,

while some said only positive bubble exists. According to Ge, X (2005), it could be considered

that we can gain excess earnings from speculation when we have a good expectation for the

market. But when the expectation is bad, speculation could help us cut loss. So positive bubble

and negative bubble exist at the same time. Finally, there are some questions about whether the

bubble will finally burst or not, and if we can control the bubbles. A lot of researches indicate that

the economic bubble has a very small probability to burst, only if the growth of price surpasses the

endurance of capital market. However, if we notice it earlier and use the proper way to control it,

the burst of bubble would be prevented. The key of controlling the economic bubble is to precisely

estimate the marginal value of when the asset bubble turns into bubble asset. If we can take

measures to prevent the burst of bubbles before it reaches marginal value, it is optimistic that the

burst of bubbles can be avoided. Asset bubble has some advantages such as it can make the market

more vigorous, but bubble asset is harmful as it already exceeds the marginal value of controllable

bubbles.


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Economic bubble and bubble economy

As for the economic bubble, when the asset bubble exists in the market, we call it economic

bubble. Whatever it is asset bubble or the bubble in the bubble asset, it is economic bubble, as it is

generated by the speculative expectation. On the other hand, bubbles in the capital market as well

as the bubbles in economic system are all economic bubble. How to test economic bubble? Ge,X

(2005) wrote that we can treat economic system as a big asset market considering there are

countless assets in the economic system. Moreover, we can also use a real market to study the

influence of bubbles on economic system. In my study I will use the second way to combine the

asset market and economic system, build the artworks asset pricing model from the microscopic

view, and build the asset bubble economic model from the macroscopic view. Just as the bubble

asset, when one of the asset market shows bubbles, and the price keeps ascending with the

continuously speculative expectations, economic bubble would turn into bubble economy.

Afterwards, when the expansion of bubbles surpasses the endurance of economic system, it would

burst because of the reverse of expectations. If we can judge the marginal value of when the

economic bubble turns into bubble economy in time, we could prevent the expansion and even the

burst. Bubble economy is very harmful, however, as for economic bubble, if we can predict and

control it, it is not appropriate to say its harmful, neither beneficial.

Changing rules of asset bubble

The transformational procedures of bubbles from quantitatively to qualitatively can be

differentiated as bubble appearing, bubble expansion, and bubble burst. As for asset market, it

reflects the processes from sub-bubble to asset bubble, and then from asset bubble to bubble asset,

finally, from bubble asset to bubble burst. Sub-bubble can be defined as the normal phenomenon

of price deviation from real value, which is not caused by the speculative expectation. Therefore,

we can make a conclusion that speculative expectation doesnt exist in the begin, however, with

the growing of speculative expectation, the price of asset change from quantitatively to

qualitatively, i.e. from sub-bubble to asset bubble, from asset bubble to bubble asset, and then

bubble burst. Thus in the research, I need to grasp three important points. First, two moments, i.e.

the moment of the showing up of sub-bubble, and the moment of bubble burst. Second, three

qualitatively transformational processes, they are the process of sub-bubble growth, the process of

the asset bubble expansion, the process of the accelerating expansion of bubble asset. Last but not

the least, three marginal values of quantitatively transformation. One is from sub-bubble to asset

bubble, another one is from asset bubble to bubble asset, and the third one is from bubble asset to

bubble burst. We should keep this in mind that the bubble burst in one of the asset market may

give rise to economic bubble or bubble economy, i.e. the bubbles in asset market will influence a

part of or the whole economic system. The synthetical impacts on the whole economic system by

all kinds of asset markets are the weighted processes of every bubble economic phenomenon in

every asset market.


Page 16

Research background

According to the 2010 global art market trend report by ARTPRICE, china was ranking first on the

basis of selling profits in auction markets. It can be considered as china already becomes an

important part of global art market. In 2010, the scale of Chinese art market grown dramatically in

accordance with the annual report by Chinese cultural department, which could be shown on the

total transaction volume that is 169,400,000,000 RMB. In line with the statistical data by Europe

art foundation, the total amount of transaction of Chinese original and antique artworks is

98,900,000,000 RMB, making up 23% of the global market. It is the first time that china surpasses

England and ascends to the second place in worldwide art market. At the same time, chinas art

auction market realized a great-leap-forward development in 2010, the total auction artworks are

300,000 pieces, and the trading volume is 230,000 pieces, the trading rate is 75%. With the

enlarging of the scale of art market, there are a lot of new developmental tendencies, such as the

development of art agency and art investment funds, the diversification of artworks, the

communication with foreign countries, etc.

The scope of Chinese artworks is very big, which includes painting and calligraphy, porcelain,

jade ware, bronze ware and other artworks. With the warming of collection, more and more new

types of artworks enter into Chinese art market, including contemporary painting and calligraphy,

handicraft and even folk-custom articles for daily use. The value of artworks shows on the

exquisite and delicate essence, excellent handwork and uniqueness. Even though China has

abundant cultural background and affluent artworks, the art market of china didnt show a

optimistic prospect in the past. In the 1990s, Chinese contemporary art was totally a blank, as

almost all of the artworks of those famous Chinese artists were focused on the Cultural Revolution

in 1960s, which also could be explained as Chinese artworks showed a one side tendency of

ideology. It was a remarkable change in the Sotheby's auction in New York in 2004 for chinas

contemporary art market. From that moment on, Chinese contemporary art market entered into a

high speed and fast growth time, many artists find their commercial value in international market.

With the rise of the international position of china, Chinese contemporary art is showing an

enormous vigor and energy. As a new market, there are still a lot of problems in it. In china, the

secondary market, i.e. auction market is the most popular market for the trading of artworks. In the

first market and third market, i.e. galleries and derivative artworks market, there are seldom

buyers and lack of the supplemented things for the auction market, even though the number of

galleries in the 21st century has grown by three times as the number of galleries in the last century.

In china, there are a lot of individual agents for the trading of artworks rather than the gallery

operating model, which end in an irregular market. However, this old and disorder style of agents

take over the first and the second market in a great extent. There are more problems other than the

deregulation of market, such as lacking of artworks valuation institution, a great deal of fake

artworks, malignance competition between galleries and auctions, skipping popularization of

artworks by galleries, being influenced by the commercial value of international capital investors,

and aimless collection by the general public of China. The problems that exist in the Chinese art

market may cause the variation of prices from the intrinsic value of artworks. However, the


Page 17

fundamental economy of china would be the basic factor that impact on the forming of bubbles in

art market. First of all, inflation is an intense problem that bothered Chinese people since 2007.

The CPI of china was more than 6% while it didnt include the prices of commercial houses.

Inflation will trigger the sudden rise of prices, when the prices are greatly deviating from the true

value of artworks, art bubbles show up. Moreover, the real estate is the carrier of bubble economy.

Giving the rational house price to income ratio should be 3 to 6, Chinese real estate market has the

largest bubbles among all of other markets in china as most of the cities price to income ratios are

all above 10, and some of the cities such as Shanghai and Beijing are even over 16. On the other

hand, the fast growing of economy attracts more and more capital, which could be shown on the

stock market. In 2007, the market value of stock market reached 120.39% of GDP, which can be

explain superficially that the development of capital market can relieve the dependence of national

economy to banking finance, thus reduce and scatter risks, at the same time, a risk and profit

symmetrical capital market can satisfy the different levels of demands of investors, ending in a

more vigorous national economy. Nevertheless, whats different from the situation of America is

the total amount of direct finance and indirect finance in chinas capital market are asymmetric.

During the first 7 months of 2007, stock market finance and refinance were 200 billion in total,

while the loans from banks were over 4000 billion. It means that most of the capital didnt go to

the real production industries but to the stock market to earn the profits from speculation. When

the rise of price related to speculation, there is a high possibility of asset bubbles. Furthermore, the

influence of appreciation of Chinese currency on the forming of bubble economy is obvious. Since

the increase of foreign investment and international capital, the foreign exchange reserve increase

and Chinese currency appreciates inevitablely. However, because china chose a peg to dollar, so in

a few years ago Chinese currency depreciated with dollar. According to some data, the real

depreciate rate was around 15%, which induced a vast of inflows of international capitals. Since

2008, china bought a great amount of American debt, and at the same time, it put a lot of Chinese

currency on exchanging dollars. Those Chinese currency were used by Americans to buy the

products in Chinese market, thus the inflation occurred because of the excess circulation of

Chinese currency. Under the circumstances, it is very easy to be considered as there are bubbles in

the art market, especially when it shows such a striking up rising in latest years. As Japan went

through a bubble economy in 1970s, I think it has some similarities between the situation in china

and that of Japan before the bubble burst. Therefore, I will introduce some information about the

Japan economy bubble and extract some idea of the forming of art bubble in china through the

analysis of Japan bubble economy.

Japan bubble economy

To talk about the background of the formation of Japan bubble economy, I start from the highly

developing economy in a long run. After the Second World War, Japan had undergone a

fluctuating, flourishing and recession period. In the 1950s, Japan realized qualitative leaps, which

was also a foundation of Japans economic miracle. The rational growth in 1960 gave a deep

impression to the rest of the world. The 1970s and 1980s are unstably growing periods. Japans


Page 18

economic bubble was fermenting, taking shape, and expanding at that time. We can get the

information of the economic situation in 1950s from Appendix 1, which shows that the investment

rate and economic growth rate are ranking the first among a few of important countries in Europe

and America. In the 1960s, the growth of economy not only showed on the continually high speed

of growth, but also on the breakthrough of economic quality. For instance, Japan realized full

employment in this period, rebalanced the international balance payment, and established

excellent heavy industry system, etc. Since 1965 to 1970, Japan had been through three brisk

markets, which are Jinmu boom, Iwato boom, Iraq's zang boom. Entering into the time of 1970s,

Japan outperformed the Income Doubling Programme, and the whole market was under a

stimulated investment condition. However, because of the Japan reconstruction plan by the

government, the bank loan was out of control, which inducing the overinvestment in real estate

market and the rise of price of lands. One of the reasons why the prices of lands increase in a great

deal is because land was regarded as the safest properties, thus it become a main object of

speculation. A distinguish feature of bank credit in Japan is the land mortgage. What we can get

from Appendix 2 is the price index of lands and the index of bank loans between 1955 and 1972.

Apart from the economic condition of Japan which could exert on the formation of bubbles, the

appreciation of Japanese Yen also influenced the expansion of economic bubbles. To explain the

reason of the cause of appreciation, I would like to make clear it on the basis of the carrying out of

the Plaza Accord by America. Since the end of the 1960s, America was in a cyclical economic

crisis. As the overvaluation of dollar, America suffered a serious adverse balance, the western

financial market undersold dollar for a lot of times, and in a rush to purchase gold, Japanese Yen,

and Deutsche Mark. On the other aspect, the oil crisis pushed America and western countries into

stagflation. Japan took the lead to break away from the dilemma in 1970s, and in 1980s, the high

growth of economy attracted the worlds attention. In order to stimulate domestic economy,

America carried out the tax reduction plan and tight money policy, which received a certain effect

on the remission of stagflation but exacerbated the adverse balance of international payment. In

1980, the trade balance between America and Japan was $7.662 billion. However, it turned out to

be $46.15 billion in 1985, which was 5 times more than that of 1980. Thus America wanted to

depreciate dollar and increase the external competitiveness. This is an important reason for the

appreciation of Japanese Yen except from the internal factors. Studying from the domestic

environment of Japan, there was a deep impression on the appreciation of Japanese Yen by the

financial internationalization and liberalization. In addition, the appreciation of Japanese Yen was

a demand of its political internationalization. Without a doubt, the appreciation of Japanese Yen

exerted a huge influence on the economy. Viewing from a short term, it triggered a Yen

appreciation depression in 1986, the actual economic growth rate declined from 5.2% to 2.6%.

Nevertheless, because of this depression, Japan caught this opportunity to change its economic

growth way from external demand orientation to domestic demand orientation. With the guide of

domestic consumption, the domestic investment came to a upsurge between 1986 and 1987, which

induced the boom of the prices of lands and stocks and speculation, as well as bubble economy.

Moreover, the financial liberalization and long term low interest rate policy acted an important

role in the formation of bubble economy. Since the end of 1970s to the beginning of 1980s,


Page 19

capitals changed from shortage to redundancy, traditional type of financial systems like divided

operation was not applicable for the development of economy, thus Japan transited into financial

liberalization and internationalization. The features of financial liberalization and

internationalization include interest rate liberalization, abolishing the restriction of the range of

banks operation, and domestic and foreign exchange funds liberalization. Because of the

diversification of free interest rates, it made speculation of lands and stocks more convenient. In

addition, the House financial specialized company applied more opportunity for a great amount of

capitals flowing into stock and real estate markets. Enterprises ignored the danger of economic

bubbles, and continued to raise more capitals by issuing stocks and convertible bonds, which

fostered the craze of investment.


Page 20

5 THE APPLICATION OF MODELS AND

FINDINGS

The chose of influencing factors

The factors that I used to specify the price of artwork in auction market are GDP, art market

transaction sum, Chinese wealthy peoples total asset, real estate investment, the Index of Chinese

Modern Art Masters and Consumer Price Index. The dependent variable is the average price of the

lots in auction market which is calculated by the total sum of the transaction of artworks in auction

market and the total transaction volume in every half year. Just as the problem that concerned by

Mei and Moses, the artworks are incomparable, so the prices are too different to put them together.

The simply summing of all the prices and dividing them by the transaction volume can not show

the true level of price in Chinese auction market. Whats done by Mei and Moses was analyzing

the repeating sales records of every artwork to get the real return rate. My object is to indicate the

factors that influence the artworks price and form the art bubbles, so I can just select the average

price as dependent variable. What I used to think about is the average price of the top 100 lots in

auction market, but it neglects the normal prices and low prices. It means it can not represent the

real situation of the whole market, thus I still insisted on the result from the transaction sum and

volume.

Jus as what I explained in the last chapter, GDP is a very important factor that will impact on the

forming of economic bubbles. GDP represent the whole economic condition of a country, the fast

growing of GDP in China will induce a new round of investment, as well as the investment in art

market. So I put GDP as the first variable in the regression model. All of the GDP data came from

the National Bureau of Statistics of China.

I collect the art market transaction sum from the Chinese Art Auction Market Survey Report by

Artron Art Market Monitoring Center. From 2003 to 2008, the transaction sum rise with an

average rate of 55% every year, showing a stunning market prospect in the future. What I can get

from this fast growth is the capitalization of art market in china is forming. The capitalization and

the operation of money in art market will raise the prices of art, and speculators will take

advantages of the flourish of this market. Like what I said before, speculation is an important

factor of the forming of economic bubbles. Thus transaction sum in auction market is a very

necessary element in the regression model for the analysis of prices.

As art collection is more like a hobby of wealthy people or a method for investment by syndicates,

so the condition of the asset of wealthy people in china is influencing the art market. I get the data

from Asia-Pacific Wealth Report, and as they are annual reports, I divided the annual data into

semi-annual data by every years growth rate, and then converted it from dollar to RMB with the

period average exchange rate published on the website of the Peoples Bank of China.

Not only the capitals in art market would be the main factors that induce the ascending of art


Page 21

prices, the condition of capital flows in the real estate market would also impact on the prices of

art. One of the questions that I wanted to solve is why the art bubbles form during the financial

crisis, thus by adding the real estate investment capitals into the regression model, I can explain

the relationship between the flourish of art market and the depression during the financial crisis.

With the financial crisis and government regulatory system, the real estate market seems to slow

down the investing speed, investors tend to look for a new opportunity in art market, so a great

deal of capitals were transferred from real estate market to art market, which means the reduce of

capitals in real estate market will increase the capitals in art market. So the coefficient between

price and real estate investment capitals would be negative. Once I was considering about the

transaction sum in the stock market, but I observed that the transaction sums are not varying too

much from 2007 to 2010 except 2008, so I didnt put it into the regression model.

A factor that can also specify the relationship between the flourish of art market and financial

crisis is the Consumer Price Index. I talked about the appreciation of Chinese currency stimulates

the formation of economic bubbles in the last chapter, and the appreciation of Chinese currency

mostly come from the favorable balance of international trade. But as china chose a peg to US

dollar, Chinese currency didnt appreciate with its actual appreciation rate. However, after the

financial crisis in 2008, Chinese currency appreciate quite a lot comparing with US dollar because

of the currency policy used by America, as a result, the inflation in the domestic market of China

seems to be more and more serious. The inflation of prices is a quite important reason for the

sudden increase of prices and explains the driving force to art price by financial crisis. Consumer

Price Index is a good index that can show the inflation rate of a whole country. I collect the data

from the National Bureau of Statistics of China.

The last factor that I chose to put in the regression model is a special art index called the Index of

Modern Chinese Art Masters, which was included in the Chinese Art Auction Market Survey

Report. I was impressed by the prices of four Chinese modern art masters paintings in 2008,

which were more than hundred million at that time. So Im looking forwards to see more

encouraging prices of modern art in the auction market, and the result is very delighted. The high

price and high quality modern artworks are dominating the whole auction market, and the modern

art index hit 8283 point in 2010 from around 2000 point in 2007. So I considered about putting the

index as an element in the regression model to see the function of modern art to the average price

of artworks in the auction market.

The analysis of influencing factors and findings

Table 1 gives the data of all the factors including GDP, art market transaction sum (AMTS),

Chinese wealthy peoples total asset (WA), real estate investment sum (RI), the Index of Chinese

Modern Art Masters (AI), and Consumer Price Index (CPI). I show them semi-annually as the

auction season takes part in every half year.


Page 22

Table 1

Average Art Price And Influencing Factors

PRICE/10thouRMB GDP/Bln RMB AMTS/Bln WA/Bln RI/Bln AI CPI

200706 16.42 11599.9 8.53994 14.69353 988.723 2670 103.2

200712 18.58 14981.1 14.6314 15.61931 1539.242 2908 104.8

200806 18.65 14047.8 12.52868 13.0769 1319.567 2662 107.9

200812 14.2 17356.7 7.61845 11.44049 1738.415 2554 105.9

200906 11.79 14820.4 6.88508 13.72589 1450.533 2420 98.9

200912 18.45 19269.9 15.64616 16.02508 2172.638 3824 99.3

201006 22.71 17361.5 20.14063 16.9188 1974.712 7530 102.6

201012 27.85 22436.8 37.21097 17.40698 2851.988 8283 103.3

In Brunnermeier and Julliard (2007)s study, they conclude that current high inflation might be

disruptive for the economy and/or inflation might proxy for future downturns, therefore depressing

current housing value, thus the high inflation in china would have a negative impact on the art

bubbles. I use the fixed base consumer price Index to deflate the average prices of artworks and

the transaction sum in art market, and at the same time, I applied GDP Index and Permanent Asset

Investment Index to deflate the GDP and real estate investment respectively. After removing the

inflation element from the historical data, I got the data in the table below

Table 2

Average Art Price And Influencing Factors(after deflating)

PRICE/10thouRMB GDP/Bln RMB AMTS/Bln WA/Bln RI/Bln AI CPI

200706 17.98 17346.3 9.35379 16.09382 1120.322 2670 103.2

200712 20.35 224040.2 16.02577 17.10783 1744.115 2908 104.8

200806 19.29 17781.71 12.95841 13.52544 1359.286 2662 107.9

200812 14.69 21970.11 7.87976 11.8329 1790.741 2554 105.9

200906 12.17 17301.33 7.10678 14.16786 1529.007 2420 98.9

200912 19.04 22495.71 16.14997 16.54109 2290.178 3824 99.3

201006 22.71 17361.5 20.14063 16.9188 1974.712 7530 102.6

201012 27.85 22436.8 37.21097 17.40698 2851.988 8283 103.3

With those data, I used Eviews to create a regression model and calculate every variables

coefficient. Then I get the table as below.


Page 23

Table 3

Variable Coefficient And Test

Dependent Variable: PRICE

Method: Least Squares

Date: 07/11/11 Time: 23:49

Sample: 200706 201012

Included observations: 8

Variable Coefficient Std. Error t-Statistic Prob.

GDP -1.27E-06 3.40E-07 -3.733359 0.1666

AMTS 0.132252 0.067847 1.949272 0.3018

WA 1.549269 0.216378 7.160017 0.0883

RI 0.001877 0.000856 2.191747 0.2725

AI 0.000125 0.000167 0.747818 0.5912

CPI 0.820924 0.106063 7.739953 0.0818

C -95.1032 14.07634 -6.756246 0.0935

R-squared 0.998935 Mean dependent var 19.255

Adjusted R-squared 0.992547 S.D. dependent var 4.776705

S.E. of regression 0.412386 Akaike info criterion 0.736847

Sum squared resid 0.170063 Schwarz criterion 0.806358

Log likelihood 4.052613 F-statistic 156.3624

Durbin-Watson stat 2.155608 Prob(F-statistic) 0.061139

Under the t-test, the critical value of 12/ knta should be 2.35. We can see from the table above that the t-statistic of AI is the smallest, so I remove AI from the regression model and run

the regression one more time. The result is shown in the Table 4


Page 24

Table 4




Date: 07/11/11 Time: 23:55

Sample: 200706 201012



GDP -1.39E-06 2.60E-07 -5.362649 0.0331

AMTS 0.147382 0.05718 2.577507 0.1233

WA 1.60022 0.181334 8.824713 0.0126

RI 0.001986 0.000745 2.665848 0.1166

CPI 0.832485 0.092649 8.985324 0.0122

C -96.9722 12.23134 -7.928177 0.0155


Adjusted

R-squared0.994189 S.D. dependent var 4.776705

S.E. of regression 0.36412 Akaike info criterion 0.93104

Sum squared resid 0.265167 Schwarz criterion 0.990621



I get the coefficients of every variable from Table 4, i.e.

b0 = -96.9722, b1 = 0.00000139, b2 = 0.147382, b3 = 1.60022, b4 = 0.001986, b5 = 0.832485.

I substitute these coefficients into the regression model, so I get the equation as below,

54321 832485.0001986.060022.1147382.000000139.09722.96 xxxxxy

Firstly, I did F test to test the significance of the regression model, which could give me a general

idea of whether the linear relationships between xi and y are outstanding or not. My hypothesis is

0: 6210 HI will test my hypothesis according to F-statistic

)/(

)1/(

KTSS

KSSF

e

R

If ),1(05.0 KTKFF , the H0 hypothesis will be rejected, which means there are


Page 25

outstanding relationship between variables and dependent variable.

As we can see from the Table 2 F-statistic is 6022.281, and according to the distribution

table, 30.19)2,5(05.0 F the F-statistic is much larger than )2,5(05.0F , thus the regression model

is reliable. We can also see that the p-value of F is 0.004145, which is smaller than the significant

value 0.05.

After the F-test, I also did the t-test to see the respective relationship between every variables and

dependent variable. Firstly I give a hypothesis as below:

0:0 jH 0:1 jH kj ,...,2,1

I give the significant value as 0.05, so if 12/ kntt a , the H0 will be rejected, which means there is significant relationship between this variable and dependent variable.

As we can see, the t-statistic of every variable is

Variable t-Statistic

C -7.928177

GDP -5.362649

AMTS 2.577507

WA 8.824713

RI 2.665848

CPI 8.985324

The critical value of t is 2.35, thus all of the variables pass the t-test. However, the p-values of RI

and AMTS are larger than 0.05, I think its because the sample volume is too small. With the

successful result of all the coefficients, I use the regression model to make a forecast prices table

to examine the coefficients one more time.

Table 5

Predictive Price And Actual Price

year price forecast actual price

200706 18.26822 17.98

200712 20.34402 20.35

200806 19.10862 19.29

200812 14.81918 14.69

200906 12.09224 12.17

200912 19.04284 19.04

201006 22.41644 22.71

201012 27.98845 27.85


Page 26

According to the table, theres no significant deviation from the actual prices, and the coefficient

determination value R2 is 0.99834, which is really high, so the regression model is very precise

for the forecast of average prices. This model is successfully tested by F-test, t-test and coefficient

determination test, therefore I can analyze the coefficient of every variables with their apparent

value in the regression model.

From Table 2 we can see the largest coefficient is the coefficient of wealthy peoples asset in china,

which shows the fundamental supporters of the art market still play an important role in the new

round of art collection boom. Even though the collectors are expanding to all kinds of classes in

Chinese society, the incremental wealth of reach people is the main force for the increase of art

prices. On the other hand, the investors in china as well as the investors from across world tend to

focus on the value of Chinese contemporary culture, thus drive the prices higher. In this view, the

booming of art market is like a revolution but not a bubble.

The second large coefficient is CPI, the appreciation of Chinese currency cause the rise of prices

in every fields including art market, although inflation in a country is a dangerous signal that the

economic bubbles are hiding under the flourish of the whole market, the sudden rise of artworks

prices by the growing of CPI doesnt show the serious problem of economic bubbles, but explains

the booming of art market during the financial crisis. Its a strong evidence to support the guess of

the connection between art market and financial crisis.

The third largest coefficient is art market transaction sum. The large amount of capital inflows to

the art market, making the prices of art rise substantially. if the capital flows in art market is the

main reason that drives the prices upward, we can know that firstly, a lot of investors in china are

tending to put their capitals in art market rather than in the real estate or stock market in these

years, and secondly, the demand of art motivate the idea of speculation, with the temptation by the

gaining from buying and selling art in auction market rather than appreciating and collecting

artworks, investors transfer their investing capitals to speculate on art, thus induce the forming of

art bubbles. However, from the value of coefficient, we cant get the idea about the driving force

by the speculative capitals.

The absolute values of the coefficient of real estate investment sum and the coefficient of GDP are

very small, thus they dont have significant relationship with the prices of artworks. The

coefficient of real estate investment is positive, which doesnt meet my hypothesis. It means that

the moving of investment in real estate market is align to the moving of art prices, and the

reduction of capital flows in real estate doesnt have too much impact on the increasing of art

prices. After the financial crisis, the growth rate of real estate market seems to slow down

comparing to the speed before financial crisis. A lot of economists in china said that speculators

and other investors transfer their capitals from real estate market to art market, thus the art bubbles

formed. From my regression model, we can see clearly that the viewpoint of them isnt verified.

The coefficient of GDP is the smallest, showing that economic background has less influence on

the prices of art. Although there are a lot of researches prove that the growth pattern of transaction

sum in art market is similar with the growth trend of GDP, we still cant prove that the GDP

growth drive the art prices upwards.

The Index of Chinese Modern Art Masters doesnt show too much influence on the prices of


Page 27

artworks. I think its because the selling volume of modern art is not big enough to dominate the

average prices of artworks, even though there are a lot of high prices of modern paintings in the

auction market. Nevertheless, I suppose the modern art will still play an important role in the

auction market in the long run, not because of the change of taste of investors, but also the art

value of Chinese modern art has reached a certain level.

From the coefficient of every variable, I cant find the significant evidence for the existence of

bubbles in chinas art market.

The research of art bubbles and findings

In accordance with the analysis of the influencing factors in the last part, we can see that the

possibility of economic bubbles in art market is under consideration. Thus I will test whether the

bubbles exist or not by explaining the standardized coefficient of certain variable. The

standardized coefficient can be acquired by the following equation:

Sy

Sxjjj , in which j is the Standardized coefficient of the value of j in the

regression, j is the unstandardized coefficient, and Sxj and Sy are the expected standard

deviation of explanatory variable and explained variable respectively. If the value of j is decreasing while the volume of variables increase, the relationship between explanatory variable

and explained variable is negative or it is not that significant. I choose a respectively fundamental

factor, which is the asset of wealthy people, as the variable to test if the standardized coefficient is

decreasing with the adding of other variables. I got the result as the Table 6 bellow:


Page 28

Table 6

standardized coefficient analysis

variables Model 1 model 2 model 3 model 4 model 5

WA 1.677355 1.801472 0.371914 0.246219 1.60022

Prob. 0.0476 0.0654 0.5401 0.6737 0.0126

St coff 0.711919 0.764598 0.157851 0.104503 0.679181

GDP -9.69E-07 2.08E-07 1.60E-07 -1.39E-06

Prob. 0.6448 0.8575 0.8852 0.0331

AMTS 0.408138 0.574075 0.147382

Prob. 0.0201 0.0415 0.1233

RI -0.003146 0.001986

Prob. 0.2992 0.1166

CPI 0.832485

Prob. 0.0122

R-squared 0.505211 0.525344 0.894281 0.931052 0.998340

As we can see, the standardized coefficients fluctuate without order. Therefore, I suppose the

economic bubbles in Chinese art market are not that significant, or the bubbles exist in some

districts but not all of the markets in china. With this guess, I calculated the average art prices in

Beijing area, Yangtze River area, and Hong Kong, Macau and Taiwan area respectively to see if

there are all bubbles exist in these regional markets. The results are included in Table 7. From the

table we can see that during the financial crisis, the art market in mainland china doesnt show

positive bubbles. The average prices of the Beijing area and Yangtze River area are lower than the

predicting prices from the end of 2008 to the middle of 2009. From the end of 2009, the average

prices of Beijing area started to show positive economic bubbles, especially in 2010, the average

price in Beijing area is 110 thousand more than the predicting price, indicating a dramatically

upward trend of art prices in that area. However, the average prices in Yangtze River area, which

includes Shanghai, Zhejiang and Jiangsu provinces, are under the average predicting price level

mostly in these years, and even in 2010. On the other hand, the art markets in Hong Kong, Macau

and Taiwan display a great harvest in these years, and the average prices in these areas are far

surpassing the predicting prices. Therefore, art bubbles exist in some places but not all of the

markets in China and the price levels in different districts are very different from each other.

Speculators use the price gaps to speculate in different regional auction markets, thus the prices of

the whole market would tend to be convergence in the future, and the art bubbles will expand in

the whole market.


Page 29

Table 7The Level of Art Bubbles In Different Area In China

Year Predicting Prices/10thou Actual Prices/10thouBubble Level

200806 19.11

Beijing area 19.59 0.48Yangtze River area 20.11 1

Hong Kong, Macau and Taiwan 36.29 17.18

200812 14.82Beijing area 12.24 -2.58

Yangtze River area 7.28 -7.54Hong Kong, Macau and Taiwan 37.34 22.52

200906 12.09Beijing area 10.17 -1.92


200912 19.04Beijing area 19.75 0.71


201012 27.99Beijing area 38.9 10.91


I cant prove that there are bubbles exist in the art market through the analysis of coefficients of

variables, however, most of the people suppose there are bubbles without any doubt. We always

treat it as a bubble when it has a stunning return rate, or when the price of it raises dramatically,

but we dont consider about one important thing which is called by the economists as money

illusion. Money illusion occurred when people ignore the inflation which would distort the

coming profits and economic calculation, thus they was convinced by the up surging prices that

they will get more profits in the future as the goods are worth more than they really are. The

investment favorites of investors like stocks, houses or artworks, are under the spotlights of people,

so the raise of prices are more clearly recorded by investors, while they ignore the prices of other

goods. With the distortion of the bubble perspective, investors will continue to invest in the

artworks and make the prices higher, and they believe that the bubbles will burst some day, so they

trade the artworks frequently, which change collection into speculation. With this assumption,

money illusion can turn the normal development of market into real bubbles. I use the raw data to

run a regression and get the coefficients as below.


Page 30

Table 8




Date: 06/25/11 Time: 03:58

Sample: 200706 201012



C -82.6047 2.170379 -38.06 0.0167

GDP 0.011077 0.000498 22.23006 0.0286

AMTS 0.947223 0.0351 26.98632 0.0236

WA 0.001945 5.34E-05 36.42429 0.0175

RI -0.07861 0.003562 -22.0687 0.0288

AI 0.000957 3.66E-05 26.18053 0.0243

CPI 0.087781 0.026606 3.299279 0.1874


Adjusted R-squared 0.999806 S.D. dependent var 4.970853

S.E. of regression 0.069186 Akaike info criterion -2.83348

Sum squared resid 0.004787 Schwarz criterion -2.76397



The largest coefficient is art market transaction sum. The large amount of capitals shows a great

demand of art in the market, which also induce the speculation. The second largest coefficient is

CPI, explaining the influence of financial crisis on economic bubbles. The coefficient of real estate

investment is negative, it means that the moving of investment in real estate market is opposite to

the moving of art prices, and the reduction of capital flows in real estate induces the increasing of

art prices. After the financial crisis, the growth rate of real estate market seems to slow down

comparing to the speed before financial crisis. A lot of economists in china said that speculators

and other investors transfer their capitals from real estate market to art market, thus the art bubbles

formed. In this regression model, the viewpoint of them is possible. GDP also has a considerable

influence on the price of art. However, the wealthy peoples asset doesnt show too much impact

on it. According to this regression model, it shows adequate evidence to support the assumption of

art bubbles, which also means under the money illusion, people have enough confidence to believe

the overvalue of art in the market. After I deflated all of the data, economic bubbles are not that

significant on the basis of the coefficients of variables.


Page 31

6 GLOBAL ART INVESTMENT FUNDS

The risks of art investment

According to the introduction of Chinese economic background and the findings from data

analysis, there are some risks that should be noticed by investors. Firstly, the risk comes from

Chinese economic condition at present and in the future as the vicissitude of art market is closely

connected to the macroeconomic. What we can see from the bubble economy in Japan is the

decline of art market after the burst of bubbles. The most representative example is a Japanese

insurance company cost 2,430 pound to by the most famous painting of Van Gogh, Sun flower.

However, after the burst of bubble economy, the painting was just worth half of that price. As

when the investors suffer a recession, they would always consider selling their collection first,

such as paintings, but not house or cars, thus the prices of artworks will decline dramatically.

Considering the economic condition in china, it seems that Chinas economy grows with a high

speed, but we can all see the economic bubbles are hiding under the flourish, from stock market to

real estate market, and now in art market, which was similar with the Japanese economic condition

before the burst of bubbles. Therefore, investors should consider about the mobility of artworks

during the recession period.

The second factor we need to notice is the price of artworks, as it could vary a lot with the

economic background, the current taste of collectors, and the speculative expectation. Lets set the

Japanese investors real experiments as example, during the 1980s, Japans economic bubbles

expanded constantly, Japanese companies acquired world-famous paintings wantonly without

considering about the irrational prices. On the New York action in 1990, a Japanese chairman of

the board expended spectacular $82.50 million and $78.10 million respectively for Van Goghs

Portrait of Doctor Gachet and Pierre-Auguste Renoirs Moulin rouge party, the price of one

painting is almost the same as a luxury hotel, but the chairman still though it was too cheap.

However, after a few years, he mortgaged those paintings to banks because of the serious loss by

his overinvestment. As the paintings were under mortgage, the bank was considering selling the

paintings, and there was an American investor wanted to offer $30 million for Moulin rouge party,

the bank didnt accepted at that time, but finally they sold it for $5 million, which was one third of

the original price. The same thing could be happen on the contemporary artworks in china as the

flourish of art market after the financial crisis is a dangerous signal that the asset bubbles in art

market are expanding.

Afterwards, the liquidity of artworks is a important factor that constitute the risk of investment. As

investors has their own tastes on artworks, and the assessment of artworks is very difficult because,

which doesnt like stocks, funds or houses, thus it is very hard to sell a artwork in a short time. It

means art investment is a long term investment, but not a short term activity. When you need to

sell an artwork to meet an emergency, it will always turn out to be a disposal with a very low

price.


Page 32

Due to the irregularity of art market in china, the whole market including collections exchange

market and auctions are filled with counterfeits. Set the collections exchange market as example,

stall keepers always make up a beautiful story, a tortuous experience to promote their things. Some

of the specialists think that most of the antiques in the market are all counterfeits, even though,

collectors still flock to it. Not only the collections market, but also the auction market is filled with

fake artworks. One of the rules of Chinese Auction Law is if the auctioneer and the client state

that they cannot guarantee the authenticity or the quality of auction objects before the auction,

they neednt to take the responsibility of flaws, Which means the auction market is not

responsible for the fake artworks, thus all of the risks are transferred to the buyers. One of the

interesting phenomenon in the Chinese art market is artists or the clients who want to sell their

artworks or belongings would rather go straightly to auction market but not galleries, which makes

the authenticate and e

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