Behavioral Failure or Market Failure? A Survey of the Beijing Real Estate Market Bubble in the Fall of 2012

Abstract

I present results from a survey of Beijing residents, conducted in the fall of 2012, to examine the factors responsible for financial bubbles such as the Beijing real estate market bubble that was occurring then. In particular, I test whether bubble-era prices accurately aggregate market participants’ inflated estimates of value, as predicted by those who describe bubbles as collective delusion (“behavioral failure”), or whether prices are higher than underlying valuations, as predicted by theories that stress institutional limits to arbitrage (“market failure”). Results support the latter prediction. Also, I show that the market could be characterized as beset by “pluralistic ignorance,” whereby the typical market participant tended to think that market prices were too high but also tended to think — erroneously — that other market participants believed that prices were reasonable. This overestimate of others’ optimism was apparently responsible for market participants’ tendency to “dance” — that is, to speculate in what they knew to be overvalued assets.