House Price Beliefs and Mortgage Leverage Choice

55 Pages Posted: 19 Jul 2017 Last revised: 29 Nov 2017

See all articles by Michael Bailey

Michael Bailey

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Eduardo Davila

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Theresa Kuchler

New York University (NYU)

Johannes Stroebel

New York University (NYU) - Leonard N. Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: July 13, 2017

Abstract

We study the relationship between homebuyers' beliefs about future house price changes and their mortgage leverage choices. From a theoretical perspective, whether more pessimistic homebuyers choose more or less leverage is ambiguous and depends on their willingness to reduce the size of their housing investment. When households primarily maximize the levered return of their property investment, more pessimistic homebuyers reduce their leverage to purchase smaller houses. On the other hand, when considerations such as family size pin down the desired property size, pessimistic homebuyers reduce their financial exposure to the housing market by making smaller downpayments to buy similarly-sized homes. To determine which scenario better describes the data, we empirically investigate the cross-sectional relationship between beliefs and leverage choices in the U.S. housing market. Our data combine mortgage financing information and a housing market expectations survey with anonymized social network data from Facebook. The survey shows that an individual's belief distribution about future house price changes is affected by the recent house price experiences of her geographically distant friends, allowing us to use these experiences as quasi-exogenous shifters of individuals' house price beliefs. We find that more pessimistic homebuyers make smaller downpayments and choose higher leverage, in particular in states where default costs are relatively low, as well as during periods when house prices are expected to fall on average. Overall, our results provide evidence for an important role of heterogeneous beliefs in explaining individuals' financial decision-making.

Keywords: Leverage, Mortgage Choice, Disagreement, Heterogeneous Beliefs

JEL Classification: E44, G12, D12, D84, R21

Suggested Citation

Bailey, Michael and Davila, Eduardo and Kuchler, Theresa and Stroebel, Johannes, House Price Beliefs and Mortgage Leverage Choice (July 13, 2017). Available at SSRN: https://ssrn.com/abstract=3001866 or http://dx.doi.org/10.2139/ssrn.3001866

Michael Bailey

Facebook ( email )

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Eduardo Davila

Yale University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Theresa Kuchler

New York University (NYU) ( email )

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Johannes Stroebel (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

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National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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