Please use this identifier to cite or link to this item: http://scholarbank.nus.edu.sg/handle/10635/33268
Title: The Dynamic Relationship between Housing Market Sentiment and Home Prices
Authors: LE THI THANH THAO
Keywords: sentiment, housing prices, fundamentals, bubbles, VAR
Issue Date: 12-Jan-2012
Source: LE THI THANH THAO (2012-01-12). The Dynamic Relationship between Housing Market Sentiment and Home Prices. ScholarBank@NUS Repository.
Abstract: Despite the potential relevance of psychological factors in explaining price movements in the housing markets, no research has directly tested the relationship between sentiment and house prices. This thesis examines the role of sentiment in setting house prices, and thus their well-documented high volatility and susceptibility to bubbles. The two research questions guiding the empirical tests in this thesis are: (1) Does sentiment have a role in explaining house price movements, above and beyond the role of fundamentals, and (2) Do past price movements predict changes in sentiment beyond the predictions of lagged sentiment and fundamentals? On one hand, sentiment is expected to positively drive home prices through its effect on the demand side in the short run. On the other hand, myopic expectations suggest a reverse causality relation from price movements to sentiment. The contribution of this study is twofold. Firstly, it introduces a set of direct proxies that appear to capture the consensus sentiment of three major agents in the housing markets, moving away from the ?residual price? measures employed in prior research. Secondly, the use of explicit indicators allows for a dynamic model to directly estimate the timing, magnitude as well as direction of impact between sentiment and house prices. Such insights are not permissible in prior studies as they infer sentiment?s effect from house price residuals. To measure and isolate sentiment?s effect, this study employs direct indicators that capture the sentiment of three major agents in the U.S. housing markets: homebuyers (demand side), builders (supply side) and lenders (intermediaries). These sentiment measures are derived from surveys conducted on a frequent basis by the University of Michigan, the National Association of Home Builders, and the Federal Reserve Board, respectively. To measure house price appreciation, this study uses the percentage change in the real Case-Shiller U.S. National Home Price Index. The dynamic relationship between housing market sentiment and housing prices is modeled in a VAR framework with two endogenous variables both expressed as linear functions of their own and each other?s lagged value. Maximum Likelihood Estimation is employed to simultaneously estimate the VAR system using quarterly data over the 1990:Q2 - 2010:Q3 sample period. Empirical results show that the sentiment of all three market participants positively influences house price appreciations in subsequent quarters. Moreover, this sentiment effect is seen to be highly persistent and takes beyond five years to correct. The sentiment-induced component becomes much larger during episodes of fast escalating and slumping house prices (i.e., the formation and bursting of housing bubbles) than in more moderate periods. This thesis also finds evidence of myopic expectations among homebuyers and lenders; however, homebuilders do not appear to be backward-looking. The dynamic interplay between sentiment and home prices is therefore a self-reinforcing process, which potentially renders housing markets highly prone to bubbles.
URI: http://scholarbank.nus.edu.sg/handle/10635/33268
Appears in Collections:Master's Theses (Open)

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