Natural Expectations and Home Equity Extraction

Roberto Pancrazi and Mario Pietrunti ()

The Warwick Economics Research Paper Series (TWERPS) from University of Warwick, Department of Economics

Abstract: In this paper we propose a novel explanation for the increase in households' leverage during the recent boom in U.S. housing prices. We use the U.S. housing market's boombust episode that led to the Great Recession as a case study, and we show that biased long-run expectations of both households and, especially, nancial intermediaries about future housing prices had a large impact on households' indebtedness. Specically, first we show that it is likely that financial intermediaries used forecasting models that ignored the long-run mean reversion of housing prices after a short-run momentum, thus leading to an overestimation of future households' housing wealth. We frame this finding in the theory of natural expectations, proposed by Fuster et al. (2010), to the housing market. Then, using a tractable model of collateralized credit market populated by households and banks, we find that: (1) mild variations in long-run forecasts of housing prices result in quantitatively considerable dierences in the amount of home equity extracted during a housing price boom; (2) the equilibrium levels of debt and interest rate are particularly sensitive to nancial intermediaries' naturalness; (3) home equity extraction data are better matched by models in which agents are fairly natural.

Keywords: Natural expectations; Home equity extraction; Consumption/saving decision; Housing price (search for similar items in EconPapers)
JEL-codes: D84 E21 E32 E44 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-dge, nep-for, nep-mac and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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https://warwick.ac.uk/fac/soc/economics/research/w ... rp_1068_pancrazi.pdf

Related works:
Journal Article: Natural expectations and home equity extraction (2019)
Working Paper: Natural Expectations and Home Equity Extraction (2015)
Working Paper: Natural Expectations and Home Equity Extraction (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:wrk:warwec:1068

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