Expectations and the housing market: A model of house price dynamics

Abstract We examine the characteristics of housing markets under adaptive and heterogeneous expectations. Model agents have finite horizons, and their borrowings are constrained by the collateral value of housing stock. Our model shows that expectation‐driven housing price dynamics constantly change the direction of movement. The steady‐state process of housing prices follows an endogenous oscillation process, and the magnitude of the cycles can be amplified by external shocks. Our quantitative results imply that (i) short‐term positive and long‐term negative serial correlations in housing price changes are inherent, (ii) house prices and expected house price movements are positively correlated, and (iii) fluctuations in housing prices are not fully explained by fundamentals.