Job Market Paper

The Causes and Consequences of House Price Momentum

Abstract: House price changes are positively autocorrelated over two to three years, a phenomenon known as momentum. This paper introduces, empirically grounds, and quantitatively analyzes an amplification mechanism that can generate substantial momentum from small frictions and demonstrates that the resulting momentum helps explain the short-run dynamics of housing markets. The amplification is due to a concave demand curve in relative price, which implies that increasing the quality-adjusted list price of a house priced above the market average rapidly reduces its probability of sale, but cutting the price of a below-average priced home only slightly improves its chance of selling. This creates a strategic complementarity that incentivizes sellers to set their list price close to others'. Consequently, frictions that cause slight insensitivities to changes in fundamentals lead to prolonged adjustments because sellers gradually adjust their price to stay near the average. I provide new micro empirical evidence for the concavity of demand—which is often used in macro models with strategic complementarities—by instrumenting a house's relative list price with a proxy for the seller's equity. I find significant concavity, which I embed in an equilibrium housing search model in which buyers avoid visiting houses that appear overpriced. I demonstrate and quantitatively evaluate the model's ability to amplify two frictions: staggered pricing and a fraction of backwards-looking rule-of-thumb sellers. Both frictions are amplified substantially, and the model explains the momentum observed empirically with a small fraction of rule-of-thumb sellers. Strong house price momentum leads households to re-time their purchase or sale, thereby explaining several features of the dynamic relationships between price, volume, inventory, and buyer and seller entry.

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