The Role of Speculation in Real Estate Cycles

Abstract

This paper develops and simulates a model to examine whether land speculation is primarily a cause of, or a symptom of, property cycles. The model suggests that the volatility of prices—the biggest purported downside of “speculation”—is strongly related to supply conditions. Moreover, while demand conditions in general, and speculation in particular, contribute to boom and bust cycles in housing and real estate markets, the impact of speculation is dominated by the effect of the price elasticity of supply. In fact, the large impacts of speculation are only observed when supply is inelastic.