Cooling Auction Fever: Evidence from the Housing Market

Abstract

This paper presents novel evidence of the effects of bidders’ behavioral biases, and sellers’ strategic responses, on the outcome of high-stakes auctions. It also provides evidence of how policies improving the information environment, and limiting the ability of sellers to exploit bidders’ biases, can be used to cool booming markets. We take advantage of the introduction of laws deterring “underquoting” in real estate auctions. Underquoting is the practice of advertising downward-biased listing prices. This practice is used by real estate agents and sellers to convey distorted signals on sellers’ reservation values, and to increase the number of auction participants. The introduction of the laws leads to higher listing prices, reducing the bias between listing prices and market valuations by 60%, and to a relative drop in auction sales prices between 2% and 6%. Our findings are not consistent with the predictions of rational models, since underquoting only increases participation by low valuation bidders. However, they are consistent with models in which higher auction participation induces overbidding through behavioral channels.

Keywords: Behavioral Biases, Auctions, House Prices, Herding

JEL Classification: D10, D80, G40, R30