Visiting Assistant Professor of Economics Selcuk Eren presented a paper titled "How Well Do Individuals Predict the Selling Prices of their Homes?" in June at the 2008 North American Summer Meeting of the Econometric Society hosted by the David A. Tepper School of Business, Carnegie Mellon University, in Pittsburgh, Pa.
Eren co-authored the paper with three other professors from Stony Brook University, Florida State University, and Universitat Pompeu Fabra. They examined the accuracy of homeowners' self-evaluation of their house prices comparing the self-reported housing wealth data with actual selling prices of homes. They found that homeowners overestimate their housing prices by more than 10 percent on average. Moreover, there is a strong correlation between accuracy and economic conditions at the time of the purchase of the property.
The magnitude of overestimation follows U.S. housing market cycles. While people who bought their houses during housing booms overestimate the value of their properties, those who bought during more difficult economic times tend to be more accurate and, in some cases, even underestimate the value of their house. The cyclicality of the overestimation of house prices can provide some important clues regarding the reasons for difficulties currently faced by many homeowners.
The researchers concluded that the pattern documented in this paper is consistent with the buildup of unrealistically optimistic expectations regarding the rate of home price appreciation among individuals who bought in good economic times and times of loose credit. These individuals end up taking on risky financial commitments that make them more dependent on price appreciation to build equity in order to accommodate an adverse event such as an increase in interest rates. The underlying methodology can be extended to analyze many other components of household portfolios that may also be affected by the overestimation of capital gains, including stock market wealth, real estate investments and even pension wealth.
Eren co-authored the paper with three other professors from Stony Brook University, Florida State University, and Universitat Pompeu Fabra. They examined the accuracy of homeowners' self-evaluation of their house prices comparing the self-reported housing wealth data with actual selling prices of homes. They found that homeowners overestimate their housing prices by more than 10 percent on average. Moreover, there is a strong correlation between accuracy and economic conditions at the time of the purchase of the property.
The magnitude of overestimation follows U.S. housing market cycles. While people who bought their houses during housing booms overestimate the value of their properties, those who bought during more difficult economic times tend to be more accurate and, in some cases, even underestimate the value of their house. The cyclicality of the overestimation of house prices can provide some important clues regarding the reasons for difficulties currently faced by many homeowners.
The researchers concluded that the pattern documented in this paper is consistent with the buildup of unrealistically optimistic expectations regarding the rate of home price appreciation among individuals who bought in good economic times and times of loose credit. These individuals end up taking on risky financial commitments that make them more dependent on price appreciation to build equity in order to accommodate an adverse event such as an increase in interest rates. The underlying methodology can be extended to analyze many other components of household portfolios that may also be affected by the overestimation of capital gains, including stock market wealth, real estate investments and even pension wealth.
