People overvalue their own homes

A lot of blame in the current financial crisis has been put on mortgage providers, who have been myopic and thought, erroneously, that house prices would always increase. Rationality would dictate that homeowners should have a better idea about the value of their own home and their capacity to service the mortgage (unless they were counting on foreclosure). So it is a natural question to ask whether home owners are rational: do they properly value their home? They can make errors, but they should not be systematic, as in the rational expectation hypothesis.

Hugo Benítez-Silva, Selcuk Eren, Frank Heiland and Sergi Jiménez-Martín answer this question by stating that homeowners overvalue by 5-10%. Interestingly, they also find that the homes tend to be undervalued when bought in hard times. Thus, by their own recognition, homeowners evaluate home prices with excess volatility. Why mortgage professionals were so myopic becomes an even bigger mystery.