SPRING, 2014


What Are You Thinking About?

Interviewed by Terry Kosdrosky

Legendary economist John Maynard Keynes coined the term “animal spirits” to describe the role of sentiment in markets. Behavioral finance researchers believe human psychology can influence markets. But they’re not always easy to measure, especially in real time. Cindy Soo, assistant professor of finance, has found a way to gauge “animal spirits” in the housing sector. Her novel research on newspaper content analysis, which uses the housing boom and bust from 2000 to 2011 as a test case, helps policymakers moderate future boom and bust cycles in the housing market.

A: Typically the standard benchmark in economics and finance is to assume that prices always reflect market fundamentals. In behavioral finance, however, we suspect that the sentiment of investors — overly optimistic or pessimistic — has the potential to overwhelm the market at times and drive prices away from their true fundamental values. This was particularly important during the boom of house prices in the 2000s, when real estate market fundamentals that historically explained house price changes simply could not explain the increases in prices we saw. But the challenge in this field of research is finding ways to quantify the sentiment of investors to even explore or test this claim. As you can imagine, capturing sentiment, or the psychological feelings of investors, is very difficult to measure. This is particularly true for the housing market, where surveys on homebuyers are expensive to implement across markets and in real time.

In my recent research, I developed a new measure of housing market sentiment by capturing the tone of newspaper coverage of local housing markets. The media presents a novel opportunity to capture sentiment because it serves as a channel and voice for the sentiment of its local community. I collected more than 30,000 local newspaper articles that cover the housing market and constructed sentiment indexes for each of the 20 cities followed by the Case-Shiller Home Price Index. These sentiment measures appear to be leading indicators for local housing prices and are able to explain a significant share of the recent housing cycle, above and beyond typical housing fundamentals.

Why is this interesting to you?

A: I think the housing market is an especially important place to study questions in behavioral finance because it is such a significant part of our economy. Over two-thirds of U.S. households own a home, and the other third is often considering whether to buy a home. Outside of your pension or retirement savings, it is often the largest asset most people hold. It is also the kind of transaction that typically only occurs a few times over a lifetime, so mistakes can have potentially huge consequences. And as we saw in the most recent financial crisis, real estate is also an asset that can have huge impacts on the financial sector. Banks and other financial institutions were intertwined with the housing market due to significant investments in mortgage-backed securities and other housingrelated assets during the crisis, and continue to be invested in real estate in many ways today. Understanding an asset market that has such large effects for both average households and the larger financial economy is critical.

What are the practical implications for industry?

A: My research so far suggests that investor sentiment, rather than fundamentals alone, has an important impact on housing prices. This is an important factor to consider when we are looking to project out how housing markets cycle, whether we are acting as an average household homebuyer or large institutional investor. Because real estate has such a large impact on the overall economy, these sentiment measures also have the potential to serve as real-time indicators of the housing market for policymakers. Certainly from a policy standpoint in the last housing cycle, knowing the direction of the overall sentiment of the housing market would have been very useful.


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