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Applied Microeconomics Group Seminar Local Economic Conditions and Subjective House Price Expectations

Speaker: Professor Melanie Lührmann, Royal Holloway, University of London

Abstract: Standard models of financial expectations predict that individuals extrapolate from past returns in their formation of expectations about future returns. Recent studies have shown behavioural biases towards linear extrapolation over longer time periods and have emphasized the role of personal experiences of past returns. Yet, as a significant proportion of individuals are poorly informed about past returns or lack financial knowledge more generally, we study the role of perceptions of past returns and of locally experienced economic conditions in the formation of subjective expectations. Using survey data from the UK Financial Lives Survey, we find that subjective expectations about one-year-ahead local housing returns are significantly influenced by perceived past local housing returns. However, as only about 50% of sample respondents hold accurate information on these, those with less financial knowledge and sophistication additionally include intuitive perceptions of local economic conditions in the set of predictors. As a consequence, expected future housing returns are lower among individuals with less financial knowledge, lower among those who live in more deprived local areas and in areas hit particularly hard by austerity-induced fiscal cuts.

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