Understanding Booms and Busts in Housing Markets

Craig Burnside, Martin Eichenbaum, and Sergio Rebelo
CQER Working Paper 12-02
February 2012

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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 consistent with these observations. Real estate agents have heterogeneous expectations about long-run fundamentals but change their views because of "social dynamics." Agents meet randomly with one another. Those with tighter priors are more likely to convert others 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.

JEL classification: E32

Key words: housing prices, real estate, social dynamics

The authors thank Eric Aldrich, Fernando Alvarez, Veronica Guerrieri, Peter Howitt, John Leahy, Martin Schneider, Rob Shimer, and Susan Woodward for their comments. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Sergio Rebelo, Northwestern University, NBER and CEPR, Department of Economics, 2001 Sheridan Road, Evanston, IL 60208, s-rebelo@kellogg.northwestern.edu; Craig Burnside, Duke University, Department of Economics, 419 Chapel Drive, Box 90097, Durham, NC 27708-0097, burnside@econ.duke.edu; or Martin Eichenbaum, Northwestern University, Department of Economics, 2001 Sheridan Road, Evanston, IL 60208, eich@northwestern.edu.

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