Overoptimism and house price bubbles

This paper explores the significance of overoptimism on house price developments in Denmark. The results indicate that house price developments historically have been partly driven by sentiments decoupled from underlying economic fundamentals, especially during strong house price booms. This underlines the need for a prudent macroeconomic stabilisation policy in periods with tight labour markets and a high degree of capacity utilisation. The paper is based on both aggregated data from the Danish Consumer Expectations Survey as well as the underlying household-level microdata behind the survey matched with administrative register data at a household level. This is the first paper that combines the use of all these three types of data. The macroeconometric part of the paper uses a standard structural VAR model to explore the historical linkages between the consumer confidence index and house prices. The analysis suggests that exogenous sentiment shocks contributed to the house price booms in both the mid-1980s and the mid-2000s. The microeconometric part of the paper finds that overoptimistic households in the 2000s were more likely to purchase real estate compared to other households, and that they leveraged more when purchasing real estate. Finally, the share of overoptimistic households involved in real estate trades was particularly large during the strong house-price boom in the mid-2000.