Do we see similar housing demand in Mumbai?

Bob Shiller (of Yale) has written a wonderful articleexplaining the recent Housing Bubbles. Shiller is an expert on matters pertaining to housing markets. He applies the principles of psychology really well to understand the developments in financial and other asset markets.

What struck me was the way in which the concept can be applied to understand housing markets worldwide.

 The failure to recognize the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world. If people do not see any risk, and see only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks.

Were all these people stupid? It can’t be. We have to consider the possibility that perfectly rational people can get caught up in a bubble. In this connection, it is helpful to refer to an important bit of economic theory about herd behavior.

Precisely. We have to consider the fact that even rational people can make poor decisions. Then he points to a paper which helps us understand the process:

Three economists, Sushil Bikhchandani, David Hirshleifer and Ivo Welch, in a classic 1992 article, defined what they call “information cascades” that can lead people into serious error. They found that these cascades can affect even perfectly rational people and cause bubblelike phenomena. Why? Ultimately, people sometimes need to rely on the judgment of others, and therein lies the problem. The theory provides a framework for understanding the real estate turbulence we are now observing.

Mr. Bikhchandani and his co-authors present this example: Suppose that a group of individuals must make an important decision, based on useful but incomplete information. Each one of them has received some information relevant to the decision, but the information is incomplete and “noisy” and does not always point to the right conclusion.

The main issue he tries to address is that best people in the business are bound to have incomplete information. So they rely on others who also have incomplete information leading to a cascade of poor decisions and what the authors call as “wrong collective action”. The finding is quite surprising:

Mr. Bikhchandani and his co-authors worked out this rational herding story carefully, and their results show that the probability of the cascade leading to an incorrect assumption is 37 percent. In other words, more than one-third of the time, rational individuals, each given information that is 60 percent accurate, will reach the wrong collective conclusion.

37% !! That is a big number. So, even if we assume rationality, there are bound to be huge errors.

The same concept can be applied to the other asset markets even in other parts of the world.

Like, we continue to see the housing prices rise (and rise and rise) in Mumbai. I have explained previously the demand curve has actually become an upward sloping curve with hardly any effect of rising prices showing on demand. The main reasons given are pretty rational ones- increase in demand for housing due to rising incomes, migration etc.

Though, I am sure large part of the rise is also because of the information cascade effect explained above. Just because someone else has bought, the other person feels it is the right time. And if he is a leader in the peer group/family, the cascade effect is bound to be larger.

Addendum:

I couldn’t find the original paper, but here is a similar kind of research paper from the same authors. It looks like an updated version as well.

Advertisements

2 Responses to “Do we see similar housing demand in Mumbai?”

  1. HmmBut Says:

    Do you know any indicator or weighted index that takes into account all the factors you mentioned? It could be interesting.

    It’s very hard to keep a cool head in a mania. I have seen that it is the cool heads that wait out, lose patience and buy at the top. That’s the saddest part.

  2. Maggieoo Says:

    i am gonna show this to my friend, bro

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.


%d bloggers like this: