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Fooled by Search: Housing Prices, Turnover and Bubbles

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  • Brian M. Peterson
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    Abstract

    This paper develops and estimates a model to explain the behaviour of house prices in the United States. The main finding is that over 70% of the increase in house prices relative to trend during the increase of house prices in the United States from 1995 to 2006 can be explained by a pricing mechanism where market participants are ‘Fooled by Search.’ Trading frictions, also known as search frictions, have been argued to affect asset prices, so that asset markets are constrained efficient, with shocks to liquidity causing prices to temporarily deviate from long run fundamentals. In this paper a model is proposed and estimated that combines search frictions with a behavioural assumption where market participants incorrectly believe that the efficient market theory holds. In other words, households are ‘Fooled by Search.’ Such a model is potentially fruitful because it can replicate the observation that real price growth and turnover are highly correlated at an annual frequency in the United States housing market. A linearized version of the model is estimated using standard OLS and annual data. In addition to explaining over 70% of the housing bubble in the United States, the model also predicts and estimation confirms that in regions with a low elasticity of supply, price growth should be more sensitive to turnover. Using the lens of turnover, a supply shock is identified and estimated that has been responsible for over 80% of the fall in real house prices from the peak in 2006 to 2010.

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    File URL: http://www.bankofcanada.ca/wp-content/uploads/2012/02/wp2012-03.pdf
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    Bibliographic Info

    Paper provided by Bank of Canada in its series Working Papers with number 12-3.

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    Length: 48 pages
    Date of creation: 2012
    Date of revision:
    Handle: RePEc:bca:bocawp:12-3

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    Related research

    Keywords: Asset pricing; Business fluctuations and cycles;

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    References

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    1. Mark Andrew & Geoffrey Meen, 2003. "House Price Appreciation, Transactions and Structural Change in the British Housing Market: A Macroeconomic Perspective," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 31(1), pages 99-116, 03.
    2. Jim Clayton & Norman Miller & Liang Peng, 2010. "Price-volume Correlation in the Housing Market: Causality and Co-movements," The Journal of Real Estate Finance and Economics, Springer, vol. 40(1), pages 14-40, January.
    3. Belen Jerez & Antonia Diaz, 2009. "House Prices, Sales and Time on the Market: A Search-Theoretic Framework," 2009 Meeting Papers 1006, Society for Economic Dynamics.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. The housing bubble: fooled by efficiency
      by Economic Logician in Economic Logic on 2012-02-22 15:11:00

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