Exploring Decision Making Biases in Bubble Markets

"This study investigates whether decision-makers are subject to behavioural biases when buying second-hand residential property. The research was conducted during 2005 when the Irish market was experiencing a property boom and demand for second-hand residential houses was higher than supply (i.e., prices were increasing by an average of 15% per year.) When buying a house by private treaty or auction, there were many competing bids, leading to difficulties closing a deal. In many cases, a bidder paid substantially more than the asking price, i.e., the market was experiencing a shortage illusion. We find evidence of the ìWinnerís Curseî at Dublin Property Auctions. We conclude that these results are due to three key issues. In the first instance, there was a shortage illusion operative in the market which fuelled demand further, and as a result there was a strong upward movement in market. Secondly, because of the competitive nature of auctions, speculative behaviour was further encouraged in the auction room, and finally there was limited information available on comparable sales, which lead to further uncertainty on the propertyís value, causing certain bidders to overestimate the value. (Winnerís Curse: when someone gets caught up in the frenzy of an auction, bids too high, & pays more than the item is worth). We also found that low property guide prices result in higher sales prices than for similar houses which had higher guides. We expected that the guide prices should be positively correlated to the sales results, i.e., high guide prices should infer higher valuations, and result in better prices. We attribute our findings to the three main issues. First, low guide prices encourage interest in the property because bidders assume that they are getting a good deal. This increases the number of bidders at the auction, leading to more competitive bidding. Second, for property auctions, bidders have invested time and money in sunk costs (e.g., search costs, property surveys, legal checks) which consequently escalates their commitment to win the auction. Third, the competitive pressures in an auction room escalate their commitment to win further, and higher prices occur. We also compared the behaviour of men vs. women bidders. Women were observed to be as likely as men to bid higher above the guide price. This disagrees with the view in Finance Literature, which states that men exhibit overconfidence more than women. The final auction study showed that Property Developers participating at auctions for investment purposes contributed to price rises. Literature from the field of Behavioural Finance suggests that the property market displayed the classic features of a speculative bubble: a situation in which temporarily high prices are sustained largely by investorsí enthusiasm rather than consistent estimation of real value. This is in contradiction with the Auction Literature which argues that a bidderís judgement improves with continued experience. The more experienced bidder should consequently be less affected by the Winnerís Curse.""