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a b s t r a c tThis paper provides a method for the analysis of the spatial and temporal diffusion of shocks in a dynamic system. We use changes in real house prices within the UK economy at the level of regions to illustrate its use. Adjustment to shocks involves both a region specific and a spatial effect. Shocks to a dominant region -London -are propagated contemporaneously and spatially to other regions. They in turn impact on other regions with a delay. We allow for lagged effects to echo back to the dominant region. London in turn is influenced by international developments through its link to New York and other financial centers. It is shown that New York house prices have a direct effect on London house prices. We analyse the effect of shocks using generalised spatio-temporal impulse responses. These highlight the diffusion of shocks both over time (as with the conventional impulse responses) and over space.

An understanding of the spatial dimension of economic and social activity requires methods that can separate out the relationship between spatial units that is due to the e¤ect of common factors from that which is purely spatial even in an abstract sense. The same applies to the empirical analysis of networks in general. We are able to distinguish between cross-sectional strong dependence and weak dependence. Strong dependence in turn suggests that there are common factors. We use cross unit averages to extract common factors and contrast this to a principal components approach widely used in the literature. We then use a multiple testing procedure to determine signi…cant bilateral correlations (signifying connections) between spatial units and compare this to an approach that just uses distance to determine units that are neighbours. We apply these methods to real house price changes at the level of Metropolitan Statistical Areas in the USA, and estimate a heterogeneous spatiotemporal model for the de-factored real house price changes and obtain signi…cant evidence of spatial connections, both positive and negative.

dx.doi.org/10.5018/economics-ejournal.ja.2007-3 This Version is available at

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