Smart Money in Dumb Money: A Survey on Beijing Real Estate Market Bubble

• In Event: 149 - Regular Session. Economic Sociology: Herds, Runs, Bubbles: Social Influences in Financial Markets

Abstract

The popular explanations of market bubbles, based on the classical economic assumption that market prices incorporate market participants’ private valuations, argue that bubbles are caused by the collective delusion of individual participants who have false beliefs of fundamental values. An emerging institutionalist approach of research, in contrast, argues that bubbles can be produced even if rational investors collectively have the resources to correct mispricing, implying that market price doesn’t necessarily incorporate true private beliefs. This paper tests the two competing explanations in the context of the Beijing real estate market, where the collective delusion explanation seems particularly appropriate since this market is dominated by amateur participants. However, my analysis of the unique survey data shows systematic and precise evidence that bubble-era prices do not equal the mean of private valuations, which strongly supports the institutionalist approach. Moreover, the survey data shed light on a novel explanation by showing that the market is driven by market participants who were drawing incorrect inferences about other participants’ beliefs—they overestimate the degree of others’ support to the price, though they personally do not endorse the price. They therefore choose “dancing”—speculating but exiting from the market before the burst of the bubbles—as the optimal strategy, but it is actually suboptimal in such a situation and fuels the bubble.

Author

• Jiayin Zhang, Massachusetts Institute of Technology