Momentum and Reversion to Fundamentals: Are They Captured by Householdss Subjective Expectations of House Prices?

Abstract

Numerous studies have found that actual house price movements exhibit momentum (short-horizon serial correlation) and reversion to fundamentals (long-horizon mean reversion). Using data from the Michigan Survey of Consumers and the Case-Shiller Survey, this paper finds that households’ subjective house price expectations capture momentum but not reversion to fundamentals. Instead, their expectations diverge from the long-run equilibrium, i.e., if the current house price is above (below) its fundamental value, households will have an even higher (lower) expectation of the future appreciation rate. The expectations of households with lower education or income diverge from the long-run equilibrium to a higher degree. The irrational expectation pattern found in this paper may affect people’s house purchasing and selling decisions and thus play an important role in driving actual house price dynamics.