An Extrapolative Model of House Price Dynamics

51 Pages Posted: 9 Jun 2015

See all articles by Edward L. Glaeser

Edward L. Glaeser

Harvard University - Department of Economics; Brookings Institution; National Bureau of Economic Research (NBER)

Charles Nathanson

Northwestern University - Kellogg School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: March 23, 2015

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.

Keywords: Housing, markets, decision sciences

Suggested Citation

Glaeser, Edward L. and Nathanson, Charles, An Extrapolative Model of House Price Dynamics (March 23, 2015). HKS Working Paper No. RWP15-012. Available at SSRN: https://ssrn.com/abstract=2614539 or http://dx.doi.org/10.2139/ssrn.2614539

Edward L. Glaeser (Contact Author)

Harvard University - Department of Economics ( email )

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Charles Nathanson

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