Advertisement

Home Price Risk, Local Market Shocks, and Index Hedging

  • DeForest McDuffEmail author
Article

Abstract

All real estate markets are local, or so the conventional wisdom goes. But just how local is local? I address this question empirically using over 75,000 repeat-sales transactions from a large suburban county of Washington D.C.. I construct and evaluate a variety of local home price indices defined by geography, price, and home type. I also calculate “house-specific” indices using locally weighted regressions with maximized kernel bandwidths. On the whole, local indices add a moderate amount of explanatory power relative to metropolitan indices. In my sample, the metropolitan index explains 50–75% of the variation in home price shocks, and local indices add 3–7% more. In an index hedging framework, homeowners should be willing to pay 5–10% to hedge with a local index versus a metropolitan index alone.

Keywords

Housing Home prices Local markets Hedging Home price index 

Notes

Acknowledgments

I thank Markus Brunnermeier, Fernando Ferreira, David Lee, Burton Malkiel, Chris Mayer, John Quigley, Ricardo Reis, Jesse Rothstein, Hyun Shin, Albert Saiz, Todd Sinai, an anonymous referee, and seminar participants at the Industrial Relations Section, Bendheim Center for Finance, and the NBER Summer Institute for Real Estate & Local Public Finance for helpful conversations and suggestions. I would additionally like to thank the National Science Foundation and Princeton University for generous financial support throughout this project.

References

  1. Bailey, M., Muth, R., & Nourse, H. (1963). A regression model for real estate price index construction. Journal of the American Statistical Association, 58, 933–942.Google Scholar
  2. Baroni, M., Barthelemy, F., & Mokrane, M. (2008). Is it possible to construct derivatives for the Paris residential market? Journal of Real Estate Finance and Economics, 37(3), 233–264.CrossRefGoogle Scholar
  3. Bourassa, S., Hoesli, M., & Peng, V. (2003). Do housing submarkets really matter? Journal of Housing Economics, 12(1), 12–28.CrossRefGoogle Scholar
  4. Bourassa, S., Hoesli, M., & Sun, J. (2006). A simple alternative house price index method. Journal of Housing Economics, 15(1), 80–97.CrossRefGoogle Scholar
  5. Case, K., & Shiller, R. (1987). Prices of single-family homes since 1970: new indexes for four cities. New England Economic Review, 5, 45–56.Google Scholar
  6. Case, K., & Shiller, R. (1989). The efficiency of the market for single-family homes. American Economic Review, 79(1), 125–137.Google Scholar
  7. Clapham, E., Englund, P., Quigley, J., & Redfearn, C. (2005). Revisiting the past and settling the score: index revision for house price derivatives. Real Estate Economics, 34(2), 275–302.CrossRefGoogle Scholar
  8. Dale-Johnson, D. (1982). An alternative approach to housing market segmentation using hedonic price data. Journal of Urban Economics, 11(3), 311–332.CrossRefGoogle Scholar
  9. Deaton, A. (1997). The analysis of household surveys. Baltimore: The Johns Hopkins University Press.CrossRefGoogle Scholar
  10. Deng, Y., & Quigley, J. (2007). Index revision, house price risk, and the market for home price derivatives. Springer, 37(3), 191–209.Google Scholar
  11. Fan, J. (1992). Design-adaptive nonparameteric regression. Journal of the American Statistical Association, 87(420), 998–1004.Google Scholar
  12. Goodman, A., & Thibodeau, T. (2003). Housing market segmentation and hedonic prediction accuracy. Journal of Housing Economics, 12(3), 181–201.CrossRefGoogle Scholar
  13. Goodman, A., & Thibodeau, T. (2007). The spatial proximity of metropolitan area housing submarkets. Real Estate Economics, 35(2), 209–232.CrossRefGoogle Scholar
  14. Maclennan, D., & Tu, Y. (1996). Economic perspectives on the structure of local housing systems. Housing Studies, 11(3), 387–406.CrossRefGoogle Scholar
  15. McMillen, D. (2004). Locally weighted regression and time-varying distance gradients. In A. Getis, J. Mur, & H. Zoller (Eds.), Spatial econometrics and spatial statistics (pp. 232–249). New York: Palgrave Macmillan.Google Scholar
  16. Shiller, R., & Weiss, A. (1999). Home equity insurance. Journal of Real Estate Finance and Economics, 19(1), 21–47.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2010

Authors and Affiliations

  1. 1.Quant Economics, Inc.San DiegoUSA
  2. 2.Industrial Relations Section, Firestone LibraryPrinceton UniversityPrincetonUSA

Personalised recommendations