Momentum and House Price Growth in the U.S.: Anatomy of a 'Bubble'
Rose Neng Lai
University of Macau - Faculty of Business Administration
Robert Van Order
University of Michigan - Stephen M. Ross School of Business; University of Aberdeen
January 1, 2009
Ross School of Business Paper No. 1124
This paper analyzes the risk-taking behavior of financial intuitions that have guarantees (e.g., banks with deposit insurance or Government Sponsored Enterprises with implicit guarantees) and/or institutions that find it beneficial to develop a reputation for not taking risk. For instance, banks putting together asset-backed securities have a choice of delivering the riskiest loans they can get away with or putting safe loans into deals because developing a reputation for selling good securities will get them larger fees later. The paper focuses on the following questions: Is it rational for financial institutions to take on less risk than they can get away with, and if it is rational, under what conditions will they shift strategies and increase their risk after having established a reputation for low risk? To answer the question we allow for future benefits from survival in the form of "franchise value", which comes from a good reputation and/or from continuing to receive a guarantee, and which they might lose if they increase risk. With franchise value they might take less risk than they are allowed; however, if they experience large enough negative shocks, they can reach a tipping point where they will change their strategy discontinuously, and "gamble for resurrection."
Number of Pages in PDF File: 45
Keywords: Price Bubble, House Prices, Regime Shift
JEL Classification: R31, R32
Date posted: January 21, 2009