Overreaction in House Price Expectations

Abstract

House prices play an important role in economic boom and bust cycles. However, little is known about the behavioral foundations of house price expectations. Using behavioral finance models, we investigate the cognitive factors behind the formation and revision process of house price expectations. We conduct a series of online studies with U.S. homeowners before and after the Fed's first meeting (Pre-study and Main Study, N = 1, 415) and follow up with the same sample (N = 1, 024) after the Fed's second meeting of the year. We explore the market uncertainty about the Fed's policy rate decision and design optimistic and pessimistic macroeconomic prediction treatments. In the Main Study, we elicit homeowners' short-term house price expectation priors, expose them to the treatments, and then measure house price posteriors. We find that homeowners overreact to information treatments relative to the Bayesian benchmark. Homeowners also exhibit asymmetric and optimistic belief revisions, suggesting that motivated reasoning can drive house price expectations. Property value and experienced house price growth history also influence the price expectation updating process. We observe significant price expectation shifts in the Follow-up study, indicating that homeowners actively monitor the macroeconomic outlook. We also detect an increase in reported exposure to news referencing Fed meetings. Our paper highlights the importance of mapping the micro-foundations of house price expectations on the verge of monetary policy changes.

Keywords: House prices, expectations, asymmetric reaction, Bayesian updating, experiment, belief entropy