Leir Center For Financial Bubble Research Working Paper #6

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2. Brief Literature Review

Many researchers have applied the Cobweb models to address different issues in different contexts. There are authors who have investigated the dynamics of a Cobweb model with heterogeneous beliefs, and/or those who conduct experiments to test the Cobweb model, such as Chen and Yeh (1996), Goeree and Hommes (2000), Sonnemans et al. (2004), Hommes (2005), Lasselle et al. (2005), Branch and McGough (2007), and Waters (2009). However, most of these models do not focus on the housing market, and more importantly, are too mathematical for general readers. In contrast, there are also many other researchers that apply econometric techniques to test the housing bubble/price, such as Englund and Ioannides (1997), Riddel (1999), Foley (2001), Labonte (2003), Green et al. (2005), Coleman et al. (2008), Goodman and Thibodeau (2008), Lai et al. (2009), and Mikhed and Zemčík (2009). However, these models are usually not based on the Cobweb models. Therefore, there exist knowledge gaps between these approaches, and the goal of this paper is to narrow some of these knowledge gaps in the context of the housing bubble.

There are also researchers that have applied Cobweb model to the housing market, and at the same time, tested the models using econometric techniques, such as Ferguson (1960), and more recently, Malpezzi and Wachter (2005), and Leung et al. (2007). However, there are still knowledge gaps between different approaches. Also, as the focus of this paper is to characterize how a housing bubble can form and burst, the empirical part of testing the model can be explored in future research. Therefore, based on the horizontal aggregation of the individual demands of speculators with bounded rationality, this research applies a simple Cobweb model to the housing bubble and derives the condition that can sustain the existence of a bubble as a self-fulfilling prophecy, at least for a short period of time.

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