Natural Expectations and Home Equity Extraction

Roberto Pancrazi and Mario Pietrunti ()

No 270215, Economic Research Papers 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, financial intermediaries about future housing prices had a large impact on households’ indebtedness. Specifically, 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 differences 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 financial intermediaries’ naturalness; (3) home equity extraction data are better matched by models in which agents are fairly natural.

Keywords: Financial; Economics (search for similar items in EconPapers)
Pages: 48
Date: 2015-05-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Natural expectations and home equity extraction (2019)
Working Paper: Natural Expectations and Home Equity Extraction (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ags:uwarer:270215

DOI: 10.22004/ag.econ.270215

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