Are Home Buyers and Sellers Rational? Do They Exhibit Behavioral Biases?

The sale or purchase of a home is the largest financial transaction for most households and can have a significant impact on household wealth. However, as LSU Department of Finance Assistant Professor Dimuthu Ratnadiwakara and his colleague show in a recent paper published in Management Science, when it comes to selling their homes, sellers exhibit behavioral biases and do not behave in a way that would maximize their wealth.

By using a unique feature of California’s property tax system, the authors identified the causal effect of sellers’ past property tax payments on their choice of the listing price. The study showed that even though past property taxes are sunk costs (costs that have already been incurred and cannot be recovered), these costs have a positive effect on the sellers’ listing price. These costs are often transmitted to the selling price, making homebuyers susceptible to behavioral biases. 

“This is an interesting study, and its publication in a premier journal testifies to its importance in illuminating market behavior in an asset that represents the single largest source of household wealth. Our students are lucky to be exposed to this kind of “hot off the press” knowledge that Dimuthu brings to the classroom. Studies like this most certainly elevate our students’ learning experiences,” commented LSU Department of Finance Chair Rajesh Narayanan.

"In this paper, we show that individuals' behavioral biases have an impact on the listing and selling prices of residential real estate. Since potential homebuyers use the listing price as an 'anchor' when arriving at the fair value for a home, biases in the listing price are mostly transmitted to the buyer.” 

Dimuthu Ratnadiwakara, Department of Finance Assistant Professor 

As for the takeaway for rational decision-making in home buying, Ratnadiwakara says, “the evidence of this paper suggests that homebuyers should be less reliant on the listing price and use other information such as selling prices of similar homes in the same neighborhood when arriving at a value of a home. This information is readily available on websites such as Zillow and Redfin."

 

Read the Full study.

About Management Science

Management Science is a scholarly journal that publishes scientific research on the theory and practice of management. The journal includes within its scope all aspects of management related to strategy, entrepreneurship, innovation, technology, and organizations as well as all functional areas of business, such as accounting, finance, information systems, marketing, and operations. The journal includes studies on organizational, managerial, group and individual decision making, from both normative and descriptive perspectives. The articles are primarily based on the foundational disciplines of computer science, economics, mathematics, psychology, sociology, and statistics, but cross-functional, multidisciplinary research that reflects the diversity of the management science professions is also encouraged. The journal interest extends to managerial issues in diverse organizational forms, such as for-profit and nonprofit firms, private and public sector institutions, and formal and informal networks of individuals. We welcome theoretical, experimental (field or lab) and empirical contributions.

The unifying thread of all Management Science articles is an analytical focus on improving the understanding of management. An acceptable manuscript must be relevant to the theory or practice of management, must meet high standards of rigor, and must be of broad interest to the community of management science scholars.

 

About the Department of Finance

The Department of Finance offers high-quality curricula to undergraduate and graduate students interested in careers in corporate finance, asset management, real estate, insurance, banking, financial planning and business law. The department boasts internationally renowned research faculty in several areas, including derivatives, asset management, banking and spatial econometrics. The department’s Securities Markets Analysis Research & Trading Lab utilizes the Bloomberg Professional service, the platform used by more than 300,000 leading business and financial professionals worldwide to make informed business decisions, and an extensive library of financial databases including the Wharton WRDS System. Additionally, the department encourages, supports and conducts research in real estate by housing the nationally renowned Real Estate Research Institute. For more information, visit lsu.edu/business/finance or call 225-578-6291.

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