Anchoring to Purchase Price and Fundamentals: Application of Salience Theory to Diagnosis of Housing Cycles

Abstract

We propose that, in addition to the first price of a repeat pair, sellers also anchor to local fundamentals at the date of the first sale. We redefine an important diagnostic tool for housing cycles by replacing the ratio of house prices to fundamentals with a salient gap: change in market value minus change in local fundamental value between any two sales. Connecticut data shows that the salient gap influences asking and market prices for sellers facing expected gains or losses and that the gap provides early, robust diagnosis of bubble conditions compared to ratios.

Keywords: Housing Cycles, Disposition Effect, House Prices and Fundamentals, Anchoring, Salience Theory

JEL Classification: E00, G11, N2, R3