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Psychology and Property Purchase Decisions
Clare BraniganJune 2009
Research Question
• Are decision-makers making rational decisions when buying property?
Outline
• Traditional Economics
• Origins of Behavioural Biases
• Literature
• Dublin Property Market
• Studies: Hypotheses, Methodology, Results
• Contributions
The role of Traditional Economics
• Traditional economics theory is derived from neo-classical economics
– Decision makers are assumed rational utility maximisers
– They make unbiased forecasts about the future
Psychology & Decision Making?
• Decision Makers and investors are subject to decision errors and biases that result in the same mistakes repeatedly
2002 Nobel prize for economics
• Daniel Kahneman (with Amos Tversky)
– For integrating “insights from psychology into economics” (Royal Swedish Academy of Sciences citation)
2002 Nobel prize for economics
• Daniel Kahneman (with Amos Tversky)
– For integrating “insights from psychology into economics” (Royal Swedish Academy of Sciences citation)
– I.e., for challenging one of the most sacred precepts of economics that people make rational decisions
Origins of Behavioural Biases
1. Human Information Processing
– Too little or too much information will lead to errors
– Beyond an optimal point, more information leads to poorer decisions
– The Decision Maker becomes swamped, ignores further new information & ultimately random decision results
2. Heuristics
– We use heuristics or short cut rules of thumb & biases to simplify the complex judgement ore decision tasks that lead to cognitive errors (Tversky & Kahneman, Science, 1974)
3. Prospect Theory
– How we deal with “loss” in making choices in the face of risk & uncertainty (Kahneman & Tversky, Econemetrica, 1979)
Key Literature
Rationality Theory of Problem Solving Simon 1957, Tayler 1985
Decision Theory Utility Theory
Multi-Criteria Decision Making
Raiffa 1968, Saaty 1990, 1995,
von Winterfeldt 1986
Brugha 2001, 2004a, 2004b
Psychology/
Behavioural Effects
Self Control Issues
Cognitive Dissonance
Heuristics and Biases
Thaler, Shefrin, 1981
Akerlof, Dickens 1982
Kahneman, Tversky, 1979
Investing - Behavioural Effects
Escalation of Commitment*
Overconfidence*
Irrational Exuberance
Shortage Illusion
Arkes, Blumer(1985)
Barber & Odean(2001)
Shiller (2000)
Thaler (2000)
Auctions The Winner’s Curse* Thaler 1998, Bazerman 1993
Property Valuation Anchoring*
Valuations
Comparative Sales Methods
Northcraft & Neale(1987)
French & Byrne (1996)
Turner 1997
McGreal et al (1998)
The representativeness heuristic
• Judgements based on stereotypes – herd mentality
• Example
– Stockmarket reaction to dot.com firm name changes in the internet boom
– Insensitivity to prior information
- Market Bubbles
Anchoring & Adjustment
• Experiments demonstrate people will even anchor on a random number
Loss Aversion
• “Losses loom larger than gains”
• Loss aversion: people are more averse to losing something they own than they are pleased to make a gain (Thaler 1980)
• “Endowment effect” : we set a higher selling price on what we own (are endowed with) than what we would pay for the identical item if we did not own it.
Loss Aversion
• “Losses loom larger than gains”
• Loss aversion: people are more averse to losing something they own than they are pleased to make a gain (Thaler 1980)
• “Endowment effect” : we set a higher selling price on what we own (are endowed with) than what we would pay for the identical item if we did not own it.
• However, standard finance, teaches that prior losses are sunk costs & irrelevant
Loss Aversion
• “Losses loom larger than gains”
• Loss aversion: people are more averse to losing something they own than they are pleased to make a gain (Thaler 1980)
• “Endowment effect” : we set a higher selling price on what we own (are endowed with) than what we would pay for the identical item if we did not own it.
• However, standard finance, teaches that prior losses are sunk costs & irrelevant
• “The sunk-cost effect is an escalation of commitment & has been defined as the Greater tendency to continue an endeavor once an investment in money, time or effect has been made”. (Arkes, Blumer,1985)
Research Programmes
• Viewed over 200 properties
• Attended and collected data from 200 Auctions
• Analyse Data relating to 1565 auction results
Dublin Property Market
• Auction Room
– “Shortage Illusion” leads to Panic buying, price becomes irrelevant
– Sunk Costs (property survey, solicitor’s fees, time at previous auctions)
– Endowment Effect
– Escalation of Commitment - View auction room as a competition, “win” at any cost
– “Herd Mentality”
– Winner’s Curse
Samples
Belmont Ave, Donnybrook
Apr 05Guide €700,000
Belmont Ave, Donnybrook
Apr 05Guide €700,000
Sold €1.36 m, 4 bidders 94% over guide price
Temple Cresent, Blackrock
May 05Guide €650,000
Temple Cresent, Blackrock
May 05Guide €650,000Sold, €1.3 m, 5 bidders100% over guide
Priory Grove, Blackrock
March 05, €730,000
Priory Grove, Blackrock
•
April 06 ?
Priory Grove, Blackrock
•
April 06 €1.8m
Which biases could be tested in an Auction Situation?
• The Winner’s Curse
– Experienced Bidders vs. non-experienced bidders
• Anchoring
– Guide prices should correlate directly to Sales Results
• Escalation of Commitment
Methodology
• Between Sept 04 and November 05, observed 200 auctions
• 100 were sold at auction, by an average of 40% over the guide price - clear evidence of Winner’s Curse
Variables
• Guide Price
• Sale Price
• Price announced on the market
• No. of Bidders
• Progression of Bids
• Previous Advertisement and Newspaper Editorials
• Characteristics of House
• Comparable Sales
• Agent
Result
Average Bid
0
10
20
30
40
50
60
70
80
1 2 3 4 5 6 7
No. of Bidders
% o
ve
r G
uid
e
100 Auctions
#bidders Avr Winning Bid
(% over Guide)
2 26
3 35
4 42
5 67
6 73
The Role of Experienced Bidders
• Experienced bidders are less likely to be affected by the Winner’s Curse.
• The opposite is true:
– Property Investors paid 63% over the guide price vs. average of 40% over the guide price
The more bids a person makes, the more committed he becomes to winning the auction.
ESCALATION OF COMMITTMENT
High Guide prices provide better Sales Results at Property Auctions
• Theory: Property valuations are influenced by initial selling price, with high initial prices, resulting in high valuation and sales price. This is an “anchoring” affect.
• High Guide prices provide better Sales Results at Property Auctions
Data Gathered
• Data on over 1500 houses was collected between Sept 2004 and Nov 2005.
Summary: 1565 Auctions
Date Total %Sold %Prior %After %WithdrawnSep-04 146 37% 3% 17% 43%Oct-04 176 40% 5% 12% 43%Nov-04 72 32% 3% 18% 47%Dec-04 11 64% 0% 18% 18%Feb-05 44 50% 2% 25% 23%Mar-05 141 53% 1% 21% 25%Apr-05 146 42% 2% 25% 31%
May-05 204 42% 10% 20% 28%Jun-05 178 44% 6% 20% 31%Jul-05 39 38% 0% 21% 41%
Sep-05 168 36% 8% 15% 41%Oct-05 143 48% 1% 24% 27%Nov-05 97 45% 2% 13% 39%
1565 44% 3% 19% 34%
Low vs. High Guide Prices
• Choose a similar selection of houses within a four mile radius –Grouped houses together by type (townhouse, semi-detached, detached), area, size and condition
Semi-D Results Before After
• Low Guide: €554/sq ft €747/sq ft
• High Guide €618/sq ft €663/sq ft
Anchoring does not occur
Estimate of Guide Price
• Estate Agents deliberately underestimated the guide price
• Prior to auction, Estate Agents stated guide price was 10-15% below market value.
• At auction Market Price was actually 23% higher than guide price (for 61 cases out of 100 auctions that marker price was announced).
Explanation:
• Lower guide prices present lower barriers to entry, which encourage more bidders to become interested in the property
• The greater number of bidders the greater chance of higher estimates, therefore the greater likelihood of the winner’s curse
• Lower guide prices encourage more bidders to have sunk costs in terms of property surveys and legal checks
• This encourages participation in the auction which results in the endowment effect
• All of which results in higher sales prices
Contributions To Literature
THEORY Result
1: The “Winner’s Curse” is Evident at Public Auctions for Residential Property
Support
2: Experienced bidders are less likely to be affected by the “Winner’s Curse .
Not-Supported
3 The more bids a person makes, the more committed he becomes to winning the auction
Supported
4 High Guide Prices provide better sales results.
Not-Supported
Implications for the Economy
• Property - Important Sector of Economy , in 2005 construction employment accounted for 12 ½ % of total employment
• The Auction method contributed to huge price fluctuations and unrealistic valuations
– Houses in “South Dublin” had 8-10 times increase in value compared to Dublin average of 4 times
– Also influenced house valuations in rest of Dublin and nearby counties
• Previous studies on property auctions are limited
• Percentage of Auctions increased each year by 25%
– By 2006 - 1,400 houses were auctioned, the majority of second-hand residential homes in South Dublin
Contributions to Public Policy
• Transparency in Sales Results
All sales prices should be available in a public register, both auction prices and private treaty sales. Winner’s Curse known to be more prevalent in the absence of complete information Changes to Guide Prices
• Changes to Auction Policy
– Houses should have to adhere to certain criteria before they can be auctioned . Reserve Price should be used only.