This article highlights a major difference in psychology between the cash market (physical home transactions) and housing derivatives trades. Might even explain the price lags in the cash market.
The Pain of Selling Your House
Why owners often remove their homes from the market even if they'd make a windfall.
By Barry Schwartz, BARRY SCHWARTZ is a professor of psychology at Swarthmore College and author of "The Paradox of Choice: Why More Is Less." October 20, 2006
YOU BOUGHT YOUR house 10 years ago for $250,000. Now you're thinking of downsizing, so you put your house on the market — for $600,000. No takers. After a few weeks, you reduce the price to $575,000. Then $550,000. An offer comes in for $520,000. You reject it and pull your house off the market, waiting for better times.
Homeowners have been doing this throughout Southern California and in other areas of the country where the housing market had previously been red hot. Why? Does this behavior make sense? Is it rational? What's the "right" price for your house?
There are two ways to look at a selling price of $520,000 for a house you bought for $250,000. One way is to start with what you paid for the house. With that as your benchmark, or anchor, $520,000 is a windfall. You've doubled your money in a decade.
The other way is to use your original asking price as your anchor. If you do that, selling at $520,000 will feel like a sizable loss.
And so, when irrational exuberance induces people in hot housing markets to put very high asking prices on their houses, the asking price, and not their original purchase price, will be the anchor for some, and having to come down from that price will hurt. How can $520,000 sting so much when it's actually a huge capital gain? Because another thing we have learned from research on decision-making is that people hate to suffer losses — and they feel far more pain from the loss of a sum of money than they experience pleasure from the gain of the same sum.
That is why when people need to sell stock to raise capital, they are more likely to sell stocks that have gone up than stocks that have gone down, which makes little sense. First, there is a chance that a stock that's going down is going down for a reason. The company may be in trouble. And second, there's a tax liability when you sell a winner and a tax deduction when you sell a loser.
Knowing these quirks in decision-making helps us understand why some people take their houses off the market even when they stand to make a very large profit by selling them. Having been seduced — by real estate agents, by the media, by their neighbors — to set a high anchor, they will feel like losers even when they double their money.
All opinions expressed herein are those of the author, and no statement should be as an offer to buy or sell any futures contract, or security or option or other derivative instrument. Trading of all such futures, securities, options and other derivative instruments entails significant risk which can result in substantial financial loss. Such risks should be fully understood prior to trading.
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