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August 13, 2010

FNC Residential Price Index vs Repeat Sales-Based Home Price Index: Revealed Bias and Home Improvement Activities

Revealed Biases and Home Improvement Activities

Oxford, Miss (August 03, 2010) - It is well known in the housing price index literature that price indices constructed from repeat-sales transactions are potentially biased due to likely changes in the quality of homes. Repeat-sales based index methodology relies heavily on the assumption that the quality of a home remains relatively constant between two sales dates. It is, therefore, crucial that the constant-quality assumption holds well in order for the price index to generate reliable measures of home price changes over time.

It is a strong assumption however, because the quality of homes does change over time. One important source of quality modification comes from home improvement-related undertakings. Since repeat-sales based index treats quality as unobservable constant, it cannot isolate and exclude the impact of rising home quality on estimated index level. Naturally, it results in over-estimation of price levels in periods in which the average quality of existing homes has been enhanced since last sales. Furthermore, the degree of overestimation increases with the pace at which home improvement activities rise. Using data on home improvement expenditures, studies found that repeat-sales index generally led to about 1% over-estimation in the rate of price appreciation during the 1970s and 1980s.

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