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Faculty of Economics

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Lake, A.

Behavioural Finance at Home: Testing Deviations of House Prices from their Fundamental Values

CWPE20104

Abstract: I introduce a new test of whether house prices are always equal to their fundamental values, which are defined to account for the unique frictions in housing asset markets, based on the speed of their reaction to monetary shocks. This test is justified with two conceptual frameworks and existing empirical work on monetary transmission. The results of applying this test to US data using local projections reject the hypothesis, but are instead consistent with behavioural expectations in housing markets. I also use a sign decomposition based on the conceptual frameworks to identify that consumption demand is the most important driver of US house price cycles, although asset demand is also relatively important. Therefore housing cycles usually arise from partially behavioural reactions to changes in housing demand.

Keywords: House Prices, Forecasting, Expectations, Housing Cycles, Monetary Shocks, Behavioural Housing

JEL Codes: G14 R31 G40 E32 D84

PDF: http://www.econ.cam.ac.uk/research-files/repec/cam/pdf/cwpe20104.pdf

Open Access Link: https://doi.org/10.17863/CAM.62317