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An Extrapolative Model of House Price Dynamics

Author

Listed:
  • Charles Nathanson

    (Kellogg School of Management, Northweste)

  • Edward Glaeser

    (Harvard University)

Abstract

A modest approximation by homebuyers leads house prices to display three attributes that are present in the data but usually missing from perfectly rational models of housing dynamics: momentum at one-year horizons, mean reversion at five-year horizons, and excess longer-term volatility relative to fundamentals. Valuing a house involves forecasting the current and future demand to live in the surrounding area. Buyers forecast using the history of transaction prices. Approximating buyers do not adjust for the expectations of past buyers, and instead assume that past prices reflect only contemporaneous demand. Consistent with survey evidence, this approximation leads buyers to expect increases in the market value of their homes after recent house price increases, to fail to anticipate the price busts that follow booms, and to be overconfident in their assessments of the housing market.

Suggested Citation

  • Charles Nathanson & Edward Glaeser, 2015. "An Extrapolative Model of House Price Dynamics," 2015 Meeting Papers 1108, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:1108
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    File URL: https://economicdynamics.org/meetpapers/2015/paper_1108.pdf
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    References listed on IDEAS

    as
    1. Karl E. Case & Robert J. Shiller & Anne K. Thompson, 2012. "What Have They Been Thinking? Homebuyer Behavior in Hot and Cold Markets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 43(2 (Fall)), pages 265-315.
    2. Xavier Gabaix, 2014. "A Sparsity-Based Model of Bounded Rationality," The Quarterly Journal of Economics, Oxford University Press, vol. 129(4), pages 1661-1710.
    3. Edward L. Glaeser, 2013. "A Nation of Gamblers: Real Estate Speculation and American History," American Economic Review, American Economic Association, vol. 103(3), pages 1-42, May.
    4. Klaus Adam & Albert Marcet & Johannes Beutel, 2017. "Stock Price Booms and Expected Capital Gains," American Economic Review, American Economic Association, vol. 107(8), pages 2352-2408, August.
    5. Elliot Anenberg & Patrick Bayer, 2013. "Endogenous Sources of Volatility in Housing Markets: The Joint Buyer-Seller Problem," NBER Working Papers 18980, National Bureau of Economic Research, Inc.
    6. Barberis, Nicholas & Greenwood, Robin & Jin, Lawrence & Shleifer, Andrei, 2015. "X-CAPM: An extrapolative capital asset pricing model," Journal of Financial Economics, Elsevier, vol. 115(1), pages 1-24.
    7. repec:hoo:wpaper:e-95-4 is not listed on IDEAS
    8. Allen Head & Huw Lloyd-Ellis & Hongfei Sun, 2014. "Search, Liquidity, and the Dynamics of House Prices and Construction," American Economic Review, American Economic Association, vol. 104(4), pages 1172-1210, April.
    9. Stefano Giglio & Matteo Maggiori & Johannes Stroebel, 2016. "No‐Bubble Condition: Model‐Free Tests in Housing Markets," Econometrica, Econometric Society, vol. 84, pages 1047-1091, May.
    10. Xavier Gabaix, 1999. "Zipf's Law for Cities: An Explanation," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 739-767.
    11. Harrison Hong & Jeremy C. Stein, 1999. "A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets," Journal of Finance, American Finance Association, vol. 54(6), pages 2143-2184, December.
    12. Colin F. Camerer & Teck-Hua Ho & Juin-Kuan Chong, 2004. "A Cognitive Hierarchy Model of Games," The Quarterly Journal of Economics, Oxford University Press, vol. 119(3), pages 861-898.
    13. Edward L. Glaeser, 2013. "A Nation Of Gamblers: Real Estate Speculation And American History," NBER Working Papers 18825, National Bureau of Economic Research, Inc.
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    Citations

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    Cited by:

    1. John Y. Campbell, 2016. "Restoring Rational Choice: The Challenge of Consumer Financial Regulation," American Economic Review, American Economic Association, vol. 106(5), pages 1-30, May.
    2. Barberis, Nicholas & Greenwood, Robin & Jin, Lawrence & Shleifer, Andrei, 2018. "Extrapolation and bubbles," Journal of Financial Economics, Elsevier, vol. 129(2), pages 203-227.
    3. Cerutti, Eugenio & Dagher, Jihad & Dell'Ariccia, Giovanni, 2017. "Housing finance and real-estate booms: A cross-country perspective," Journal of Housing Economics, Elsevier, vol. 38(C), pages 1-13.
    4. repec:eee:dyncon:v:83:y:2017:i:c:p:215-231 is not listed on IDEAS
    5. Michael Bailey & Ruiqing Cao & Theresa Kuchler & Johannes Stroebel, 2016. "Social Networks and Housing Markets," NBER Working Papers 22258, National Bureau of Economic Research, Inc.
    6. Kuchler, Theresa & Zafar, Basit, 2015. "Personal experiences and expectations about aggregate outcomes," Staff Reports 748, Federal Reserve Bank of New York.
    7. Smith, Scott & Fuller, Debra & Bogin, Alex & Polkovnichenko, Nataliya & Weiher, Jesse, 2016. "Countercyclical capital regime revisited: Tests of robustness," Journal of Economics and Business, Elsevier, vol. 84(C), pages 50-78.
    8. Alexander N. Bogin & Stephen D. Bruestle & William M. Doerner, 2017. "How Low Can House Prices Go? Estimating a Conservative Lower Bound," The Journal of Real Estate Finance and Economics, Springer, vol. 54(1), pages 97-116, January.
    9. repec:pal:easeco:v:45:y:2019:i:4:d:10.1057_s41302-019-00141-8 is not listed on IDEAS
    10. repec:eee:inecon:v:108:y:2017:i:c:p:169-190 is not listed on IDEAS
    11. Basit Zafar & Theresa Kuchler, 2015. "Expectation Formation," 2015 Meeting Papers 678, Society for Economic Dynamics.
    12. Cozzi, Guido & Davenport, Margaret, 2017. "Extrapolative expectations and capital flows during convergence," Journal of International Economics, Elsevier, vol. 108(C), pages 169-190.
    13. Daniel L. Tortorice, 2019. "Long-Run Expectations, Learning and the US Housing Market," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 45(4), pages 497-531, October.
    14. Rünstler, Gerhard & Balfoussia, Hiona & Burlon, Lorenzo & Buss, Ginters & Comunale, Mariarosaria & De Backer, Bruno & Dewachter, Hans & Guarda, Paolo & Haavio, Markus & Hindrayanto, Irma & Iskrev, Nik, 2018. "Real and financial cycles in EU countries - Stylised facts and modelling implications," Occasional Paper Series 205, European Central Bank.

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