On the Rationality of the Housing Market: Project-Level Evidence from China's First-Tier Cities

This paper examines the rationality of the residential housing market. We adopt a proprietary dataset covering China’s first-tier cities from 2009 to 2016 that consists of project-level rents and repeated selling prices and identify investors’ “underreaction” phenomenon to the cash flow news. With the benefit of this project-level dataset, we demonstrate that research in this field suffers serious aggregation bias for omitting the heterogeneity in dynamic interactions among micro- and macro-level variables. Aggregation leads to a wrong conclusion that investors’ reaction to cash flow news is nearly rational or they slightly overreact. We therefore argue that research on the pricing behavior in the residential housing market has to be conducted at a disaggregated level.