Understanding the Drivers of Housing Prices: Fundamental versus Expectational View

Abstract This paper empirically confronts two different channels driving the 2000s boom‐bust and the recent strong appreciation of house prices in Europe. The first channel, the fundamental view, is characterized by income and credit. While the expectational view is based on the expectations of households and construction firms. I propose a Panel Factor Augmented Vector Autoregressive (FAVAR) model that can determine these views' importance. First, the results show that expectations play a significant role in short‐ and medium‐run fluctuations of house prices, explaining 30% and 20%, respectively. Second, the effect of a household's belief shock on house prices depends on the level of mortgage credit liberalization. Specifically, in countries with looser credit conditions, household beliefs significantly impact house prices. While in countries with tighter credit conditions, the impact is not significant. Overall, this research provides new evidence that credit market conditions can influence the effect of expectations on house prices.