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 models, we investigate the cognitive factors behind the formation and revision process of house price expectations. We conduct a series of online studies that leverage market uncertainty about the Fed’s policy rate decisions. We design treatments with optimistic and pessimistic macroeconomic predictions. Homeowners overreact to these information treatments relative to the Bayesian benchmark. They also exhibit asymmetric and optimistic belief revisions, suggesting that motivated reasoning can drive house price expectations. Property value and past 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 price change dynamics in the market. Our paper highlights the importance of mapping the micro-foundations of house price expectations on the verge of monetary policy changes.