💰 quantitative finance

Exploring Drivers of Extreme Housing Prices in Australia

This paper utilizes a differential equation model and extreme value techniques to demonstrate that supply limitations have decoupled Australian house prices from mortgage rates, indicating that an 11% rate hike is required to curb extreme costs unless housing supply is increased through deregulation or reduced government competition.

Original authors: Grace Burtenshaw, Ashley Burtenshaw, Meagan Carney

Published 2026-04-22

📖 5 min read🧠 Deep dive

CC BY 4.0

Original authors: Grace Burtenshaw, Ashley Burtenshaw, Meagan Carney

Original paper licensed under CC BY 4.0 (http://creativecommons.org/licenses/by/4.0/). ✨ This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer

The Big Picture: The "Unstoppable" House

Imagine the Australian housing market as a massive, heavy truck driving up a hill. Usually, if you press the brakes (raise interest rates), the truck slows down or stops. But recently, the drivers (the economy) have noticed something strange: no matter how hard they press the brakes, the truck keeps speeding up.

This paper asks: Why won't this truck stop? And what do we actually need to do to get it to slow down?

The authors, a team of mathematicians and economists, used a mix of historical data and complex math models to find the answer. Their conclusion? The brakes are broken because the road is too narrow.

1. The "Decoupling" Mystery

For decades, there was a predictable relationship between mortgage rates (the cost of borrowing money) and house prices.

The Old Rule: If the government raised interest rates, borrowing became expensive. People bought fewer houses. Demand dropped, and prices went down. It was like a thermostat: turn up the heat (rates), and the room cools (prices).

What Changed?
Around 2020, this relationship broke. The authors call this "decoupling."

The Analogy: Imagine you are trying to cool a room by opening a window (raising rates). But someone has taped the window shut (supply limits). No matter how much you try to open it, the room stays hot.
The Finding: Since 2020, raising interest rates has had almost zero effect on stopping house prices from rising. The "thermostat" is broken.

2. The Real Culprit: The Supply Bottleneck

Why did the brakes stop working? The authors looked at two main suspects: People moving in (Migration) and New Houses being built (Supply).

Suspect A: Migration. Many people think, "Too many people are moving here, so houses are too expensive."
- The Verdict: The math says no. They found that while migration is up, it doesn't directly explain why prices are skyrocketing.
Suspect B: The Supply Chain. This is the real villain.
- The Analogy: Imagine a restaurant with a huge line of hungry customers (Demand). If the kitchen is small and the chefs are slow (Supply), the restaurant can't serve everyone. Even if you raise the price of the menu (Interest Rates), the customers are still desperate to eat, and the few tables available become incredibly expensive.
- The Finding: Australia isn't building enough new homes. Before 2020, they were building houses fast enough to keep up with demand. After 2020, the "kitchen" got clogged. Builders ran out of materials, workers, or permits. Because there are so few new houses, people are fighting over the existing ones, driving prices up regardless of interest rates.

3. The Mathematical "Crystal Ball"

The authors built a computer model (a set of equations) to simulate the future. They fed it data on how many houses are being built, how many people want them, and what interest rates are doing.

The Result: The model confirmed that as long as the "kitchen" (supply) stays clogged, raising interest rates won't work.
The Extreme Value Test: They also looked at the "worst-case scenarios" (extreme price spikes). They found that before 2020, a small rate hike could stop a price spike. After 2020, the same rate hike actually made the price spike worse (or had no effect).

4. The Shocking Conclusion: The "Impossible" Rate Hike

Here is the most dramatic part of the paper. The authors calculated exactly how much interest rates would need to rise to finally slow down house prices if we don't fix the supply problem.

The Calculation: To stop the "truck" from speeding up right now, the interest rate would need to jump by 11 percentage points.
The Reality Check: If the current rate is 6%, they are saying we would need to raise it to 17%.
The Implication: This is economically impossible. It would crash the entire economy, cause massive unemployment, and ruin people's lives. It proves that raising rates is not a viable solution anymore.

5. What Should We Do? (The Solution)

The paper argues that we are trying to fix a plumbing problem by turning up the heat.

The Wrong Fix: Keep raising interest rates. This is like pressing the gas pedal while the car is stuck in mud; it just spins the wheels and burns fuel.
The Right Fix: Build more houses.
- The authors suggest we need to unblock the supply chain. This means deregulation (making it easier to get permits), reducing competition between the government and private builders for resources (like workers and materials), and actually building more homes.
- The Analogy: You don't fix a traffic jam by telling cars to drive slower (rates); you fix it by building more lanes (supply).

Summary in One Sentence

Australia's housing market is broken because we aren't building enough homes; trying to fix it by raising interest rates is like trying to put out a fire with a water pistol—you need to build more houses (supply) to actually solve the problem, or the rates would have to go to impossible levels to work.

1. Problem Statement

The paper addresses the Australian housing crisis, characterized by a rapid, unexplained resilience in house price growth despite significant government interventions and rising mortgage rates. Historically, increased mortgage rates were used to dampen demand and lower prices. However, recent observations (post-2020) suggest a "decoupling" phenomenon where mortgage rate hikes no longer effectively moderate house prices.

The authors aim to:

Analytically investigate the drivers of this observed resilience.
Identify the specific mechanisms causing the decoupling between mortgage rates and house prices.
Quantify the effectiveness of current policy tools (specifically interest rates) in controlling extreme price movements.
Propose policy reforms based on mathematical modeling and statistical evidence.

2. Methodology

The study employs a hybrid approach combining data-driven statistical analysis, Ordinary Differential Equation (ODE) modeling, and Extreme Value Theory (EVT).

A. Data-Driven Investigation

Data Sources: Australian Bureau of Statistics (ABS) and Bloomberg.
Variables: Mean dwelling value, mortgage rates, dwelling completion values (supply), and net migration (demand proxy).
Initial Analysis: The authors identified a generalized logistic relationship between mortgage rates and dwelling values prior to 2020. Post-2020, this relationship broke down.
Key Finding: While net migration showed no direct correlation with dwelling values, dwelling completion values shifted from a positive linear relationship with prices (pre-2020) to no relationship (post-2020), indicating a supply-chain bottleneck.

B. Mathematical Modeling (ODE System)

To understand the underlying dynamics, the authors constructed a system of differential equations:

House Price Dynamics ( $Y$ ): Modeled as a function of mortgage rate ( $X$ ) and natural linear growth ( $k$ , representing inflation).
$\frac{dY}{dt} = \alpha \frac{dG}{dX} \frac{dX}{dt} + (1-\alpha)k$
Where $G(X)$ is a generalized logistic function and $\alpha$ is a coupling parameter.
Coupling Parameter ( $\alpha$ ): Defined by a smooth Hill-type transition function dependent on the ratio of Supply ( $S$ $S$ ) to Demand ( $D$ $D$ ):
$\alpha(S, D) = \frac{(S/D)^2}{(S/D)^2 + C^2}$
- $\alpha \gg 0.5$ : Prices driven by mortgage rates.
- $\alpha \ll 0.5$ : Prices driven by inflation/natural growth.
Supply and Demand Dynamics:
- Supply ( $S$ ): Modeled with logistic growth ( $r, K$ ) minus consumption proportional to price ($cSY$).
- Demand ( $D$ ): Modeled as a function of mortgage rate and time ($aX + bD$).

C. Extreme Value Theory (EVT)

To forecast extreme price movements, the authors used the Block Maxima method from EVT:

Proxy Variable: Due to limited dwelling value data, they used Helia Group stock prices (Australian Mortgage Insurance) as a proxy, validated by a strong correlation ( $\rho = 0.78$ ).
Modeling: A Non-stationary Generalized Extreme Value (GEV) distribution was fitted to monthly maxima for two periods: 2014–2019 (pre-decoupling) and 2021–2025 (post-decoupling).
Covariates: The location ( $\mu$ ) and scale ( $\sigma$ ) parameters of the GEV were defined as functions of Mortgage Rates and Consumer Price Index (CPI).

3. Key Contributions

Quantification of Decoupling: The paper mathematically defines the "decoupling" of mortgage rates from house prices, attributing it to a shift in the coupling parameter $\alpha$ driven by supply constraints.
Integration of ODE and EVT: It bridges the gap between deterministic dynamical systems (understanding why the relationship changed) and probabilistic extreme value analysis (predicting how extremes behave under new conditions).
Policy Ineffectiveness Quantification: The study provides a specific numerical threshold for policy intervention, demonstrating that standard interest rate hikes are no longer sufficient.

4. Key Results

A. Model Dynamics

Parameter Evolution: The coupling parameter $\alpha$ initially increased but has steadily declined post-2020. This indicates a shift from mortgage-rate-driven pricing to inflation and structural supply-demand imbalances as the primary drivers.
Supply Constraints: The model projects a continuous decrease in supply relative to demand, confirming that the housing market is supply-constrained rather than demand-driven in the traditional sense.

B. Extreme Value Analysis (Pre- vs. Post-2020)

Pre-2020 (2014–2019): A 1.0 percentage point increase in mortgage rates successfully offset a 10-point increase in CPI, shifting the distribution of extreme prices to the left (lower prices).
Post-2020 (2021–2025): The same changes (1.0% rate hike + 10-point CPI) resulted in a rightward shift (higher extreme prices). The moderating effect of mortgage rates has been nullified.
The 11% Threshold: To counteract a 10-point CPI increase and prevent an upward shift in extreme prices under current dynamics, the model calculates that mortgage rates would need to increase by at least 11.0 percentage points. This is deemed economically unfeasible.

C. Demographic Factors

Net migration was found to have no statistically significant direct relationship with mean dwelling values in either period, challenging the narrative that population inflow is the primary driver of the current price resilience.

5. Significance and Policy Implications

Structural vs. Cyclical: The findings suggest the housing crisis is a structural supply issue, not merely a cyclical demand issue. Traditional monetary policy (interest rate adjustments) is ineffective because the supply chain cannot respond quickly enough to price signals.
Policy Recommendations:
- Supply-Side Focus: Effective policy must target the housing supply chain through deregulation or reduced competition with government building projects.
- Resource Allocation: Addressing bottlenecks in labor, materials, and planning approvals is critical.
- Limitations of Rates: Relying solely on interest rate hikes to cool the market is futile and potentially damaging, as it requires unrealistic rate increases (11%+) to achieve marginal price control.
Conclusion: The "indestructible" nature of Australian asset prices is a result of supply limitations. Without addressing the supply chain, price resilience will persist regardless of monetary tightening.