Sentimental Shocks and House Prices

We investigate the impact of sentimental shocks on house price fluctuations in the Euro area. To this end, we isolate and measure non-fundamental-based sentimental shocks by employing survey-based indicators that proxy four key types of expectations of housing market participants. The novelty of our study is that specific sentimental shocks are identified through four uncertainty transmission channels in the real estate market (i.e., the precautionary savings channel, the credit supply channel, the credit demand, and the inflationary channel). We provide strong evidence that sentimental shocks drive fluctuations in house prices even in the absence of any changes in aggregate fundamentals. Finally, we find that these results are more pronounced in the peripheral Euro area countries. The finding that the real estate market is also governed by irrational behavior implies that both governments and policymakers should consider sentimental shocks when they form their real estate market policies or take actions to stabilize and improve the proper function of the European housing market.