| Summary: | For most people, the purchase of a home constitutes the most significant investment of their lives, yet little attention is generally paid to the state of the housing market with regards to its fundamental value. With the last housing bubble firmly in the rear-view mirror, and optimism at relative highs, it is of vital importance that we remain conscious of the fact that irrational exuberance can always, and will eventually become the reigning regime. The first half of the thesis explores how house prices are generally determined on a macroeconomic scale. We provide a brief overview of the methodology commonly used for the construction of several different price indices that statistical agencies rely on for various purposes. Additionally, we construct our own price indices based on a select few of these methods, using actual Icelandic house sales data for the capital area spanning the years 2011-2020. Our results indicate that nominal prices have increased by roughly 111-114% in nominal terms during the period, or roughly 80-83% in real terms. This is lower than indicated by the price indices constructed by Statistics Iceland and Registers Iceland, which show a nominal increase of roughly 120-121% and real increase of roughly 88-89%. In the latter half of the thesis, our main goal is to take a closer look at the speculative dynamics that are hypothesized to control asset markets, with special emphasis placed on residential housing markets. We opt to look at non-rational factors as a general phenomenon found in asset markets and observe how these factors can indeed affect housing markets, leading us to the question we seek to answer: does the Icelandic housing market display common signs of non-rational pricing? Our results indicate that the Icelandic housing market does indeed display the three main signs of non-rationality, that is, momentum, mean reversion and excess volatility. To support this conclusion, we estimate a heterogeneous agent model based on extrapolative expectations for the period Q1 1994 to Q3 ...
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