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Expectation-Based Model Explaining Boom and Bust Cycles in Housing Markets

Purpose - Before the year 2000, the housing prices in Korea were increasing every decade. After 2000, for the first time, Korea experienced a decrease in housing prices, and the repeti-tive cycle of price fluctuation started. Such a "boom and bust cycle" is a worldwide phenomenon. The current study proposes a mathematical model to explain price fluctuation cycles based on the theory of consumer psychology. Specifically, the model incorporates the effects of buyer expectations of future prices on actual price changes. Based on the model, this study inves-tigates various independent variables affecting the amplitude of price fluctuations in housing markets. Research design, data, and methodology -Thestudypro-vides theoretical analyses based on a mathematical model. The proposed model uses the following assumptions of the pricing mechanism in housing markets. First, the price of a house at a certain time is affected not only by its current price but also by its expected future price. Second, house investors or buyers cannot predict the exact future price but make a subjective pre-diction based on observed price changes up to the present. Third, the price is determined by demand changes made in pre-vious time periods. The current study tries to explain the boom-bust cycle in housing markets with a mathematical model and several numerical examples. The model illustrates the ef-fects of consumer price elasticity, consumer sensitivity to price changes, and the sensitivity of prices to demand changes on price fluctuation. Results - The analytical results imply that even without ex-ternal effects, the boom-bust cycle can occur endogenously due to buyer psychological factors. The model supports the expect-ation of future price direction as the most important variable causing price fluctuation in housing market. Consumer tendency for making choices based on both the current and expected fu-ture price causes repetitive boom-bust cycles in housing markets. Such consumers who r