Abstract

The authors use recent panel data and various empirical models to investigate the validity of the irrational expectations
hypothesis and the feedback theory in the UK housing market. The authors provide the first empirical evidence to
justify the statistically significant and positive feedback causality effect between the changes in bubbles and the
contemporaneous changes in house prices. While they have found evidence to support the idea that the irrational
expectation hypothesis best fits the UK housing market in the short-run, the authors failed to find evidence in support
of the feedback theory. The authors observe that an increase in bubbles could cause a subsequent decrease in house
prices, ceteris paribus, suggesting that people also learn from their mistakes and attempt to compromise by acting as
rationally as possible. Overall, the authors observe that the causality effects are asymmetrical, being more significant
from bubble to house price than they are from house price to bubble.