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Heterogeneous Beliefs, Nonlinear Dynamics and Housing Market Instability
Last modified: 2017-05-27
Abstract
This paper surveys recent research on the impact of investors’ behavioural heterogeneity on the dynamics of housing markets. A large body of literature on housing dynamics relies on the rational and representative agent framework, where house price movements are ultimately due to
sequences of exogenous shocks affecting the 'fundamentals' of the housing market. Real estate market efficiency is an implication of such
rationality assumptions.
Despite the remarkable achievements from this approach, a number of housing market phenomena are far from being fully understood, such as
boom-bust housing cycles (Wheaton 1999, Shiller 2007) and the observed short-term positive autocorrelation of house price returns (Case and
Shiller 1990). Therefore, research on housing dynamics has started to accept the view that investors’ heterogeneity and bounded rationality
(such as herd behavior and reliance on simple behavioral rules) may play a role in house price fluctuations.
In recent years, a number of Heterogeneous-Agent Models of the housing market have been developed (see, e.g. Dieci and Westerhoff 2016, and
references therein), inspired by the well-established Heterogeneous Agent approach to financial markets (recently surveyed by Hommes 2013). A
stylized two-belief framework with extrapolative and regressive expectations incorporates in a tractable way the behavioral heterogeneity of agents and proves to be a useful tool to understand housing bubbles and crashes and the way they interact with the ‘real side’ of housing
markets. In contrast to standard linearization techniques, tools from nonlinear dynamics (such as bifurcation analysis) are crucial to investigate
the behavior of such models.
References
Case, K. and Shiller, R. (1990): Forecasting prices and excess returns in the housing market. Journal of the American Real Estate and Urban Economics Association 18, 253-273.
Hommes, C. (2013). Behavioral Rationality and Heterogeneous Expectations in Complex Economic Systems. Cambridge University Press: New York.
Shiller, R. (2007): Understanding recent trends in house prices and home ownership. Cowles Foundation Discussion Paper 1630. Yale University,
New Haven.
Wheaton, W. (1999): Real estate “cycles”: some fundamentals”. Real Estate Economics 27, 209-230.
sequences of exogenous shocks affecting the 'fundamentals' of the housing market. Real estate market efficiency is an implication of such
rationality assumptions.
Despite the remarkable achievements from this approach, a number of housing market phenomena are far from being fully understood, such as
boom-bust housing cycles (Wheaton 1999, Shiller 2007) and the observed short-term positive autocorrelation of house price returns (Case and
Shiller 1990). Therefore, research on housing dynamics has started to accept the view that investors’ heterogeneity and bounded rationality
(such as herd behavior and reliance on simple behavioral rules) may play a role in house price fluctuations.
In recent years, a number of Heterogeneous-Agent Models of the housing market have been developed (see, e.g. Dieci and Westerhoff 2016, and
references therein), inspired by the well-established Heterogeneous Agent approach to financial markets (recently surveyed by Hommes 2013). A
stylized two-belief framework with extrapolative and regressive expectations incorporates in a tractable way the behavioral heterogeneity of agents and proves to be a useful tool to understand housing bubbles and crashes and the way they interact with the ‘real side’ of housing
markets. In contrast to standard linearization techniques, tools from nonlinear dynamics (such as bifurcation analysis) are crucial to investigate
the behavior of such models.
References
Case, K. and Shiller, R. (1990): Forecasting prices and excess returns in the housing market. Journal of the American Real Estate and Urban Economics Association 18, 253-273.
Hommes, C. (2013). Behavioral Rationality and Heterogeneous Expectations in Complex Economic Systems. Cambridge University Press: New York.
Shiller, R. (2007): Understanding recent trends in house prices and home ownership. Cowles Foundation Discussion Paper 1630. Yale University,
New Haven.
Wheaton, W. (1999): Real estate “cycles”: some fundamentals”. Real Estate Economics 27, 209-230.
Keywords
Housing markets; Heterogeneous expectations; Boom-bust cycles; Nonlinear dynamics
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