Understanding Booms and Busts in Housing Markets

Some booms in housing prices are followed by busts. Others are not. It is generally di¢ cult to Önd observable fundamentals that are useful for predicting whether a boom will turn into a bust or not. We develop a model consistent with these observations. Agents have heterogeneous expectations about long-run fundamentals but change their views because of ìsocial dynamics.îAgents with tighter priors are more likely to con- vert others to their beliefs. Boom-bust episodes typically occur when skeptical agents happen to be correct. The booms that are not followed by busts typically occur when optimistic agents happen to be correct.