Agenda Week 1: 16 September 2003

Psychology and Property Purchase Decisions Clare Branigan June 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, Self Control Issues Cognitive Dissonance Heuristics and Biases Thaler, Shefrin, 1981 Escalation of Commitment* Overconfidence* Irrational Exuberance Shortage Illusion

Arkes, Blumer(1985) Auctions The Winners Curse* Thaler 1998, Bazerman 1993 Property Valuation Anchoring* Valuations Comparative Sales Northcraft & Neale(1987) Psychology/

Behavioural Effects Investing - Behavioural Effects von Winterfeldt 1986 Brugha 2001, 2004a, 2004b Akerlof, Dickens 1982 Kahneman, Tversky, 1979 Barber & Odean(2001) Shiller (2000) Thaler (2000) French & Byrne (1996) Turner 1997 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, solicitors fees, time at previous auctions) Endowment Effect Escalation of Commitment - View auction room as a competition, win at any cost Herd Mentality Winners Curse Samples Belmont Ave, Donnybrook

Apr 05 Guide 700,000 Belmont Ave, Donnybrook Apr 05 Guide 700,000 Sold 1.36 m, 4 bidders 94% over guide price Temple Cresent, Blackrock May 05 Guide 650,000 Temple Cresent, Blackrock

May 05 Guide 650,000 Sold, 1.3 m, 5 bidders 100% 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 Winners 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 Winners 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 100 Auctions #bidders Avr Winning Bid

(% over Guide) Av e rage Bid % ov e r G uide 80 70 60 50 40 30 20 10 0 1 2

3 4 5 No. of Bidders 6 7 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 Winners Curse. The opposite is true: Property Investors paid 63% over the guide price vs. average of 40% over the guide price ESCALATION OF COMMITTMENT The more bids a person makes, the more committed he becomes to winning the auction. 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 Sep-04 Oct-04

Nov-04 Dec-04 Feb-05 Mar-05 Apr-05 May-05 Jun-05 Jul-05 Sep-05 Oct-05 Nov-05 %Sold 146 176 72 11 44

141 146 204 178 39 168 143 97 1565 %Prior 37% 40% 32% 64% 50% 53% 42%

42% 44% 38% 36% 48% 45% 44% %After 3% 5% 3% 0% 2% 1% 2% 10% 6%

0% 8% 1% 2% 3% 17% 12% 18% 18% 25% 21% 25% 20% 20% 21% 15% 24%

13% 19% %Withdrawn 43% 43% 47% 18% 23% 25% 31% 28% 31% 41% 41% 27% 39% 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 winners 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 Winners Curse is Evident at Public Auctions for Residential Property Support 2: Experienced bidders are less likely to be affected by the Winners 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 % 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. Winners 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.

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