Home Price Risk, Local Market Shocks, and Index Hedging

DeForest McDuff

Online First™, 22 May 2010

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

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