Home Price Risk, Local Market Shocks, and Index Hedging
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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.
KeywordsHousing Home prices Local markets Hedging Home price index
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.
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