– The purpose of this exploratory paper is to examine the lack of reliability of traditional neo-classical models and to argue that it is due to the hidden complexity and non-linearity that may operate at times in residential housing markets. As a result, market efficiency may be a special case, rather than the prevailing rule. An alternative framework that incorporates the higher order concepts of complexity – based on the non-linear, emergent behavior of multiple agents – is required to model discontinuities and imbalances in the housing markets.
– The paper examines the building block concepts required to model the complexity of the housing market and analyzes their implications. These implications can be counter-intuitive and help explain the failure of policy makers to model the recent bust in global housing markets.
– The paper finds that policy makers need to adopt an analytical framework that incorporates non-linearity, emergence and other building blocks of complexity in order to construct representative financial models that help understand systemic imbalances that may afflict residential housing markets.
– This is the first paper to one's knowledge that argues that policy makers should adopt an alternative theoretical framework based on complexity concepts in order to create more effective financial models; such models should include indicators that provide early warning signals of potential discontinuities in housing markets.
