**1. Introduction**

The housing market is closely associated with consumer spending, implying that an increase in house prices boosts homeowners' confidence. Similarly, a decline in house prices raises concerns for the homeowners due to the risk of losing the value of their property resulting in a reduction in spending and holding off personal investments. Thus, house prices have become an indicator of the economic performance of a country [1, 2]. Gallin [3] and Costello et al. [4] further show the importance of the role of housing in the economy and the effects of the underlying economic factors on house prices.

Transmission of regional housing prices within one single country has been researched widely over the years [5–11]. Regarding the UK, most of the literature focuses on the ripple effect – i.e. house prices initially originate from London and the South East and are then transmitted to the rest of the country [5, 9].<sup>1</sup> This implies that the housing market in London is the main transmitter of shocks, but developments in other regions have no impact on London. Geographical proximity to London appears to be a decisive factor in relation to the ripple effect [5]. Holly et al. [12] and Cook and Watson [9] report that it takes more time for a shock in the housing market of London to propagate another UK region when this region is relatively distant from London. Further according to Holly et al. [12] any other UK region may have an impact on London prices; however, this impact is relatively short-term.

<sup>1</sup> Antonakakis et al. [5] and Cook and Watson [9] provide an excellent survey of the papers in literature that investigate the ripple effect in the UK housing market. Cook and Watson [9] also provide a good discussion of the different empirical methods applied in these papers.

Connectedness is defined as the inter-linkage or dependence between two or more-time series [13]. The key differences between connectedness and ripple effect relate to implications in terms of Granger causality. Ripple effect only shows unidirectional shock transmission whereas Connecteness implies bidirectional Granger causality among the underlying variables. Zhu et al. [14] show that rising connectedness may be due to the information spillover considering investment aspects of the housing market which may come from geographically adjacent or economically linked regions. Our study contributes to the literature by empirically investigating the *connectedness vs the ripple effect* between the house prices in London and 13 other regions of the UK.

This chapter studies the price transmission mechanism driving the UK regional house prices using linear causality and the nonlinear Granger causality model proposed by Hiemstra and Jones [15], and the impulse response. Application of the non-linear causality test and impulse response on the UK housing market makes this study unique in the literature. Linear and non-linear forecasting tests are further conducted as a robustness check. This chapter, thus investigates the *connectedness vs the ripple effect* between the house prices in London and other regions of the UK. The key focus is to show that the changes in house prices in the UK are transmitted in a bidirectional manner between London and most of the country. According to Antonakakis et al. [5] this may have implications for investors seeking efficient diversification of investment across mortgage backed assets across various regions in the country. Further, identification of regional disparities can help policymakers and investors to achieve more balanced growth across the regions under study. This chapter is motivated by Antonakakis et al. [5] who claim that recent empirical evidence is rather inconclusive about the actual manifestation of the ripple effect and further by Cook and Watson [9] who advocate further research in this field.

Our results show bidirectional dependence between the London house prices and other regions' prices except for Northern Ireland and Wales. Thus, we provide evidence of connectedness among the house prices in London and other regions of the UK. This result is confirmed by linear causality, the nonlinear causality and impulse response tests. Further empirical examination applying linear and nonlinear forecasting tests back the linear and non-linear causality results.

The format of the chapter is the following. Section 2 describes the data and the empirical methodology employed. Section 3 discusses the results, and Section 4 presents the conclusion and implications.

### **2. Data description and methodology**

#### **2.1 Data**

This study is based on UK regional housing quarterly prices' data ranging from Q4–1973 to Q2–2018 obtained from the Nationwide website<sup>2</sup> for 13 regions; these are London, East Anglia, East Midlands, North, North West, Northern Ireland, Outer Metropolitan, Outer South East, Scotland, South East, South West, Wales, West Midlands, and Yorkshire and Humberside. The different regions of the UK exhibit certain and unique characteristics. Northern Ireland is unique in the sense it has achieved an increased level of independence from the UK government since the late 1990s when it comes to social security provisions and the taxation of its housing market [16]. Further there is a strong link between the housing markets of the

<sup>2</sup> https://www.nationwide.co.uk/about/house-price-index/download-data

*UK House Prices – Connectedness or Ripple Effect? DOI: http://dx.doi.org/10.5772/intechopen.98868*

Northern Ireland and the Republic of Ireland [17]. Similarly Wales also achieved increased level of independence from the UK government after the 1997 devolution. East Midlands is a region with a very strong manufacturing in the country and is considered important when it comes to the production sector of the economy [5]. In contrast the West Midlands has a relatively poor economic conditions [18]. According to ONS [19], the South West is one of the UK regions with the highest rates of employment and economic activity. Given the uniqueness, strength and location relative to London of these other regions, it is possible for house prices in these regions to impact London house prices. **Figure 1** shows the approximate location of the 13 regions relative to London. **Figure 2** presents all the prices normalised to one at the start, including the UK. The close movements of all the indices are clearly visible. The rising prices across all regions during the mid-1980s and falling prices during the financial crisis of the late 2000s are clearly prominent.<sup>3</sup>

This figure shows the regional house prices of the UK normalised to one at the start of the sample period; i.e. 1973Q3 – 2018Q2.
