The study of cognitive psychology sheds light on how people reason, make choices, and allocate their attention, among other things. The psychology literature argues that people's emotions affect information processing and decision-making. In particular, negative mood states significantly affect people's decisions. Buying or selling a home is one of the most important economic decisions people face in their lives. Financial losses in housing can cause large and irreparable consequences to homeowners. With the high stakes associated with financial decisions in the real estate market, it offers a unique laboratory to assess the potential impact of sentiment. In financial markets, market sentiment, broadly referred to as the overall expectations and beliefs of market participants towards a particular security or market, is believed to be an important determinant of asset prices. 1 In this paper, we propose to construct a sentiment measure to examine the impact of sentiment on real estate-one of the most distinctive and important asset classes that typically comprises a significant portion of one's overall wealth. Unlike the stock market, the housing market features a relatively higher percentage of individual investors, extremely segmented and localized markets, higher levels of information asymmetry, and lack of short-sale mechanisms, all of which make it highly likely to be affected by investor sentiment (Clayton, Ling, & Naranjo, 2009; Hui & Wang, 2014). There have been justifiable discussions pertaining to the impact of sentiment on residential real estate pricing. However, published empirical studies that we are aware of fall short of providing a comprehensive way to measure sentiment of market participants in the residential real estate market by directly observing their behavior.

We use Google search frequency to construct a measure of aggregate sentiment in housing markets—Financial, Economic, and Real Estate (FEAR) Index—and analyze its relationship to housing returns. We find that housing markets react inversely to changes in FEAR Index, which captures negative sentiment, and that market characteristics affect the strength of this relationship. More financially distressed markets, as measured by bankruptcy rates and mortgage default double trigger, are more responsive to changes in FEAR Index than less distressed markets, and cold markets (markets with slow price appreciation) are more responsive than hot markets (markets with rapid price appreciation). We also examine these characteristics jointly and find that cold markets with financial distress are the most responsive to negative sentiment. Finally, we show that home prices are more sensitive to negative sentiment during recessionary periods.

No abstract