Expectations and the Housing Market: A Model of House Price Dynamics

Abstract

We investigate the feature of housing markets under adaptive and heterogeneous expectations. Model agents have finite horizons and borrowings are constrained by the collateral value of housing stock. Our model shows that expectation-driven house price dynamics constantly change the direction of movement. The steady-state process of house prices follows an endogenous oscillation process, and the magnitude of the cycles can be amplified or repressed by shocks to household leverage. Our quantitative results imply that i) the short-term positive and long-term negative serial correlations in house price changes are inherent, ii) house prices and expected house price movements positively co-move, and iii) fluctuations in house prices are not fully explained by fundamentals.

Keywords: Bounded rationality, Endogenous cycles, Extrapolative expectation, Housing bubbles, Housing prices

JEL Classification: E32 , E71 , R31