Academic journal article Economic Review - Federal Reserve Bank of Kansas City

A Guide to Aggregate House Price Measures

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

A Guide to Aggregate House Price Measures

Article excerpt

In recent years, the United States, like many other industrialized nations, has experienced wide swings in the growth rate of housing prices. Understanding these price changes is important for a number of reasons. Housing serves as a major source of individual wealdi. Hence, changes in its value may influence consumer spending and saving decisions, in turn, affecting overall economic activity. More narrowly, changes in housing prices both impact and reflect the health of the residential investment sector, a major source of employment. Further, house prices are the key determinant of housing affordability, an important public policy goal in many countries.

To understand the behavior of housing prices and their influence on the economy, it is crucial to have an accurate measure of aggregate housing prices. In practice, however, it is difficult to develop such a measure. Housing is an extremely heterogeneous good, and houses are sold only infrequendy. Heterogeneity makes it difficult to distinguish between aggregate and individual price variations. The infrequency of sales implies that, in any time period, prices are not observed for most houses.

In the face of such challenges, three methodologies have been developed to measure the aggregate price of housing. The first methodology simply takes an average over all observed prices, with no attempt to control for heterogeneity. The second looks at repeat sales of the same property. The third treats a house as a bundle of attributes, each with its own price that changes over time.

This article provides an overview of the three methodologies for pricing housing and a detailed guide to the major house price indices used by housing analysts. The analysis suggests there is no one "best" measure of housing prices. Each of the three methodologies has conceptual advantages and disadvantages, and the empirical house price indices have practical advantages and disadvantages as well. Which is best depends on the question being addressed.

The first section of the article examines why it is so difficult to measure the aggregate price of housing and how each of the three methodologies addresses these problems. The following three sections describe each methodology in more depth and describe some leading house price series based on each. The final section briefly compares the behavior of a representative series of each methodology over the period 1990 through 2006 and then provides examples of problems for which one or another representative series is likely to be most appropriate.


The two main problems measuring the price of housing are heterogeneity and the infrequency of sales.1 This section explains how the interaction of these two problems interferes with measurement. Next, it introduces each of the three methodologies that try to overcome these problems.

Measurement problems

The first of the two measurement problems is the tremendous heterogeneity among houses. No two houses are the same. At the very least, they differ in location. They may differ in neighborhood, city, or metro area. Even the difference of a few hundred feet can have an appreciable price effect. Obviously, so too will other attributes, ranging from the number of bedrooms and bathrooms to building style and state of repair. Naturally, observed differences in characteristics between two houses will be reflected in differences in price.

The specific combination of attributes, both locational and physical, associated with any particular house can be thought of as corresponding to that houses "quality." As is intuitive, quality captures the grade of workmanship and materials within a house. But it also is meant to capture virtually every other variation in attributes. So, for example, a two-bedroom house is of higher quality than a one-bedroom house (all else equal). Similarly, a house in a desirable location is of higher quality than a house in an undesirable location (all else equal). …

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