Caught in the Housing Crash: Model Failure or Management Failure?

Abstract

I apply standard time series models to US housing prices. Forecasts made in 2005 or earlier would have produced stress scenarios that are worse than the subsequent actual change in housing prices. The probability of these scenarios is in the range that financial institutions should consider in their risk management. Results are robust across a wide range of specifications, and fundamental prediction models lead to the same conclusions. Hence, the fact that the crash caught many market participants by surprise should not be attributed to deficiencies in standard prediction models. Many market participants seem to have focused on the trend predictions, giving too little consideration to risks.