Trick or Trade: An Examination of Cognitive Illusions Embedded in Real Estate

We explore the possibility that illusionary components in prices trigger cognitive illusions in real estate markets, which can affect the significance of the informational content of prices. Under this new illusionary paradigm we build up a model where we assume that the price of a security (e.g. the IPD index) is given by two components: A fundamental value, and an illusionary adjustment which is trigger by the illusion of validity and the illusion of control, and is reinforced by the clustering illusion. The illusionary components embedded in the prices produce a series of emotes in financial markets, units of emotion, which represents the smallest impulse of emotional reactions. In other words, the illusionary components mislead investorís sentiment, making traders become more influence by emotions and fears. Moreover, when these emotes are îhappeningî in a short space of time they create a cascade of feelings that develops into an emotional habit forcing traders to desperately find a way to control the situation and/or find a subjectively convincing explanation about what is happening. We test our model using different real estate indexes and databases, showing that illusions have a significant impact in European real estate markets. This interesting result not only shows that illusions should be taken into account, but also helps us to a better understanding of price dynamics and bubbles in real estate markets