Volatile prices scare investors away ... except in the housing market

Price volatility in uncertain markets tends to scare investors away. This is why when volatility jumps in the stock markets, potential buyers hold on to their orders as sellers send prices tumbling.

But if jumping into uncertain waters doesn't feel good, then why is it that researchers found that the more uncertain prices are in the housing market, the more that people dive in and buy?

James Banks, Richard Blundell, Zoé Oldfield, and James P. Smith studied the relative volatility of different housing markets in the US and UK and found two big things: People are more likely to purchase a home earlier in life in places that have high price volatility, and people are more likely to move up to a larger house in those same uncertain conditions.

The researchers acknowledge this seems to go against common sense.

"Typically, risk-averse individuals will avoid risky assets as volatility increases. In this paper we show that owner-occupied housing is an exception to this rule," they wrote.

The researchers divided the US into two groups based on the percent change of housing prices between 1974 and 1998. Normalizing it on 1980 data, prices fluctuated the most in Massachusetts, where the price from trough to peak doubled. The rest of New England, New York, California, and Hawaii also topped the volatility list. South Carolina was the flipside, with a trough to peak change of only 15%.

They found that for people ages 21 to 35 - what they loosely define as the group forming household for the first time - there is a 40% higher chance of purchasing a home during that time in a high volatility state than one with lower volatility.

Additionally, a young household is much more likely to move up to a house of higher value in those riskier areas.

Their reasoning behind this is simple. As households are formed and grow larger, there is a need to continue to move up the "housing ladder," and buy larger homes to accommodate growing families. If there is a possibility that the prices will continue to go up, it is better to have equity in a house already and make a smaller leap.

Keeping up with the Joneses

Let's break it down, say the Bakers, a newly married couple, decide to rent a one-bedroom townhouse and their friends, the Joneses, purchase a one-bedroom home instead.

Two years later each couple welcomes a new child into the family, meaning both need to move up to a two-bedroom. The Bakers and Joneses have been saving diligently and in fairly equal amounts. During those two years, however, housing prices have skyrocketed in their city.

Since the Joneses own their home, their asset's (the house) value has increased with the market. They will now get more money for the house, making it easier to move up to the bigger place.

The Bakers' cash, however, did not increase with the housing market, comparatively deprecating against the value of the house they want to buy. That makes it harder to keep up with the Joneses.

This applies not only for the first home but those in a volatile market will be more likely - as the Jeffersons once did - to move on up to two- or three-bedroom homes quicker.

The researchers found that people seem to intuitively understand that even those the waves of housing waters may bigger, it's better to just go ahead and jump in.