Extrapolative Beliefs, Strategic Complementarities, and Housing Booms

We develop a model of incomplete information and extrapolative expectations in housing markets. Agents rationally anticipate immediate house price reactions after observing a noisy signal about a fundamental but extrapolate this belief to future house prices. This house price extrapolation leads to strategic complementarities among both buyers and lenders as well as between the two groups. The model can generate simultaneous increases in the supply of mortgages as well as the demand for housing as observed during the build-up phase of the Global Financial Crisis. We discuss a variety of potential policies that curb the housing market from entering a boom phase, such as changes in the policy rate, transaction taxes, and government guarantees.