Return Chasing and Investments: Evidence from the Housing Market

Abstract

Using a nationally representative sample of wealthy home owners and their investment records during the recent housing boom, I show that investors reporting high home value appreciation on their own primary residences in the past are more likely to make future investments in the housing market by remodeling their home or purchasing a new investment property. The impact of perceived returns from the past on future investment decisions is short-lived and hump-shaped, roughly doubles in size during the peak of the housing boom, and is much stronger for younger investors. This investment strategy does not appear to be driven by an increase in wealth, (expected) changes in permanent income, relaxed credit constraints through rising collateral values, willingness to take nancial risks, or the q of the house. Further decomposing perceived returns on housing using zip code level returns, home owners' subjective valuation of their own homes is found to be chie y responsible for the observed investment strategy. These ndings suggest that feedback from return to expectation to behavior may have ampli ed the housing boom. ∗I am grateful to my committee members Jonathan Parker (Chair), Annette Vissing-Jorgensen (Co-Chair), Meghan Busse, and Paola Sapienza for helpful guidance and insightful comments. I also thank Snehal Banerjee, Efraim Benmelech, David Hirshleifer, Arvind Krishnamurthy, Camelia Kuhnen, David Matsa, Robert McDonald, Brian Melzer, Mitchell Petersen, Anthony Wray, and seminar participants from Kellogg for constructive suggestions. Generous nancial support for this paper from the NBER Household Finance Working Group, the Alfred P. Sloan Foundation, the Zell Center for Risk Research, and the Department of Finance at Kellogg School of Management is gratefully acknowledged. All errors are my own. This paper was previously titled Return Chasing and Investments: Evidence from the Housing Market . ©In Gu Khang. All rights reserved. 699 Boylston Street, Boston, MA 02116. E-mail: i-khang@cornerstone.com