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Fooled by Search: Housing Prices, Turnover and Bubbles

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  • Brian Petereson

    () (Indiana University Bloomington)

Abstract

Theory predicts that the effects of search frictions on house prices from temporary movements in demand should be temporary, while the data suggests it is permanent. The latter implies that movements in demand coupled with search frictions create higher volatility in prices than theory would predict, amplifying price changes, leading to bubbles and depressions. To generate permanent price changes from temporary demand shocks, a textbook search model is combined with a behavioral assumption where house buyers and sellers ignore the effects of search frictions on past prices. The estimated model implies that over half of the real price growth from the housing bubble starting in 1998 is due to the behavioral assumption where households are ‘Fooled by Search.’ When trend growth of prices is removed, the behavioral assumption explains almost three-fourths of the housing bubble. The estimated model also provides several other results. (1) There is a large inefficiency in the search process of the housing market: buyers have very little bargaining power relative to their impact on creating sales, i.e. the Hosios condition is not met by an order of magnitude. (2) There is evidence of a rise in the fundamental value of houses from 1998 to 2005 that mirrors the loose monetary policy under the Greenspan Federal Reserve. (3) Analysis of the boom and bust of the housing market from 1975 to 1982 suggests that buyers who are choosing to not enter the housing market are rational. Using the last observation to make a back of the envelope projection for the current crisis, turnover will have to fall to its 1982 level and remain there until 2011 before a recovery can begin, driving house prices down to their real levels of 2002-2003

Suggested Citation

  • Brian Petereson, 2009. "Fooled by Search: Housing Prices, Turnover and Bubbles," Caepr Working Papers 2009-004, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  • Handle: RePEc:inu:caeprp:2009-004
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    Cited by:

    1. Garner, Thesia I. & Verbrugge, Randal, 2009. "Reconciling user costs and rental equivalence: Evidence from the US consumer expenditure survey," Journal of Housing Economics, Elsevier, vol. 18(3), pages 172-192, September.
    2. Gaetano Lisi, 2014. "Home-seekers in the Housing Market," International Real Estate Review, Asian Real Estate Society, vol. 17(1), pages 47-62.
    3. Gaetano Lisi, 2013. "On the Functional Form of the Hedonic Price Function: A Matching-theoretic Model and Empirical Evidence," International Real Estate Review, Asian Real Estate Society, vol. 16(2), pages 189-207.
    4. Granziera, Eleonora & Kozicki, Sharon, 2015. "House price dynamics: Fundamentals and expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 60(C), pages 152-165.
    5. Gaetano Lisi, 2013. "Can the Mortensen-Pissarides Model Match the Housing Market Facts?," Journal of Economics and Econometrics, Economics and Econometrics Society, vol. 56(2), pages 78-92.
    6. Gregory Bauer, 2014. "International House Price Cycles, Monetary Policy and Risk Premiums," Staff Working Papers 14-54, Bank of Canada.
    7. Akkoyun, H. Cagri & Arslan, Yavuz & Kanik, Birol, 2013. "Housing prices and transaction volume," Journal of Housing Economics, Elsevier, vol. 22(2), pages 119-134.
    8. Masanori Kashiwagi, 2014. "Sunspots and Self-Fulfilling Beliefs in the U.S. Housing Market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(4), pages 654-676, October.
    9. Kronick, Jeremy, 2015. "Do Loan-to-Value Ratio Regulation Changes Affect Canadian Mortgage Credit?," MPRA Paper 73671, University Library of Munich, Germany.
    10. Gaetano Lisi, 2013. "Matching Models and Housing Markets: the Role of the Zero-Profit Condition," Economic Research Guardian, Weissberg Publishing, vol. 3(1), pages 54-60, June.
    11. Gaetano Lisi, 2012. "Can the Mortensen-Pissarides Model Match the Housing Market Facts ?," Working Papers hal-00676072, HAL.
    12. Lisi, Gaetano, 2013. "Equilibrium Dynamics in a Matching Theoretic-Model of the Housing Market," MPRA Paper 62317, University Library of Munich, Germany.
    13. Pascal Towbin & Sebastian Weber, 2015. "Price Expectations and the U.S. Housing Boom," IMF Working Papers 15/182, International Monetary Fund.
    14. Lisi, Gaetano, 2012. "On the theoretical derivation of a functional form for the hedonic price function," MPRA Paper 37066, University Library of Munich, Germany.

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