An Extrapolative Model of House Price Dynamics

Edward L. Glaeser and Charles G. Nathanson
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Edward L. Glaeser: Harvard University
Charles G. Nathanson: Northwestern University

Working Paper Series from Harvard University, John F. Kennedy School of Government

Abstract: A modest approximation by homebuyers leads house prices to display three features that are present in the data but usually missing from perfectly rational models: 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 past transaction prices. Approximating buyers do not adjust for the expectations of past buyers, and instead assume that past prices reflect only contemporaneous demand, as with a capitalization rate formula. 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.

Date: 2015-03
New Economics Papers: this item is included in nep-for and nep-ure
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