Authors: H Bao, C Lizieri
Year: 2024
Journal / publisher: The Routledge Handbook of Housing Economics
Link: Publisher page
Abstract
This chapter reviews recent applications of behavioural economics and behavioural science to housing markets with a focus on finance. We take as our starting point articles by Marsh and Gibb (2011) and Smith (2011) from Housing Theory and Society, written in the immediate aftermath of the Global Financial Crisis (GFC). The GFC has been seen as a substantial challenge to conven- tional financial economics and housing finance is portrayed as the core of the crisis itself. To what extent has financial economics, applied to housing markets, incorporated behavioural models to explain the boom, crisis and subsequent recovery – at least until the global Coronavirus pandemic once again provided a profound shock to markets?
Marsh and Gibb and Smith begin with nuanced critiques of “conventional” or “neo-classical” economic models of housing markets and assumptions of market efficiency and rational eco- nomic behaviour in such models. They question whether models based on rational choice or utility maximisation can explain house price dynamics, given the behaviour of individual actors in the market and the characteristics of property. The growing body of behavioural sci- ence evidence that individual decision-making deviates systematically from that of expected utility theories, allied with the housing market’s heterogeneity, information asymmetry and infrequent transactions, suggests that models based on rational behaviour are unlikely to gener- ate robust results.
Marsh and Gibb focus on the decision to move, proposing a decision-making process that compares the utility of moving to staying (accounting for loss aversion, endowment effects and other behavioural traits) and with consumption relativity to a reference group, arguing that this provides a superior explanatory framework. In general, these traits favour the status quo over moving, creating inertia that suppresses transaction activity and mobility; however, the reference group (and potential regret from missed opportunities) could trigger more activity in rising markets accelerating price gains, linking to the much-quoted (and often misinter- preted) Keynesian idea of animal spirits (Akerlof & Shiller, 2010) and Shiller’s (2005) irra- tional exuberance. A key economic question that arises from this is why do such “irrational” states persist?