An Extrapolative Model of House Price Dynamics

Charles Nathanson and Edward Glaeser
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Charles Nathanson: Kellogg School of Management, Northweste
Edward Glaeser: Harvard University

No 1108, 2015 Meeting Papers from Society for Economic Dynamics

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.

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