DP8232 Understanding Booms and Busts in Housing Markets

Author(s): Craig Burnside, Martin Eichenbaum, Sérgio Rebelo
Publication Date: February 2011
Keyword(s): housing prices, real estate
JEL(s): E32
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8232

Some booms in housing prices are followed by busts. Others are not. In either case it is difficult to find observable fundamentals that are correlated with price movements. We develop a model that is consistent with these observations. Agents have heterogeneous expectations about long-run fundamentals but change their views because of "social dynamics". Agents meet randomly and those with tighter priors are more likely to convert other agents to their beliefs. The model generates a "fad": the fraction of the population with a particular view rises and then falls. Depending on which agent is correct about fundamentals, these fads generate boom-busts or protracted booms.