Do house prices overreact to relevant information? New evidence from the UK housing market

Abstract

We use recent panel data and various empirical models to investigate the validity of the irrational expectations hypothesis and the feedback theory in the UK housing market. We provide the first empirical evidence to justify the statistically significant and positive feedback causality effect between the changes in bubbles and the contemporaneous changes in house prices. While we have found evidence to support the idea that the irrational expectation hypothesis best fits the UK housing market in the short-run, we failed to find evidence in support of the feedback theory. We observe that an increase in bubbles could cause a subsequent decrease in house prices, ceteris paribus, suggesting that people also learn from their mistakes and attempt to compromise by acting as rationally as possible. Overall, we observe that the causality effects are asymmetrical, being more significant from bubble to house price than they are from house price to bubble