House Price Dynamics with Heterogeneous Expectations

This paper presents a dynamic equilibrium model of the housing mar-ket in which agents consume housing services and speculate on future price changes. The model features a \u85xed supply of housing and a random vari-ation in demand, originating from the fact that agents hold heterogeneous expectations about the future course of prices. The important feature of the model is that heterogeneous expectations generate a non linear demand for housing: agents expecting higher future prices buy in anticipation of capital gains; agents holding pessimistic expectations prefer to rent to avoid capital losses. Because pessimistic agents rent their expectations are not incorpo-rated in the price for owned houses. As a consequence, the equilibrium price reects only the expectations of optimistic agents and is thus biased upward. We test the predictions of the model with US city data, using the disper-sion in city income as a proxy for information dispersion. The empirical evidence supports the prediction that house prices are higher in cities with more dispersed beliefs about future economic conditions. JEL: R 21, R 23, G1