Application of Hedonic Housing Prices as indicator of Spatial

Economic Inequality
Richa Mallik
Indian Institute of Technology, Kanpur

Introduction
This document analyzes the spatial dynamics of housing prices using econometric techniques from Hedonic
house price models; further, it extends the results to probe relationship between spatial income distribution
and housing prices estimated, using classical econometric methods. It also tests for the significance of housing
prices as indicator for spatially distributed economic inequality, measured in terms of income distribution.

Spatial Hedonic Model

Spatial Econometrics is the set of those econometric methods which deal with the inconsistency and bias
caused by not accounting spatial auto-correlation and spatial heterogeneity in cross-sectional and space time
observations. Hedonic price models relate price of a commodity to weighted combination of its different
characteristics, at supply and demand market equilibrium. Thus, Spatial Hedonic model employs two stage
estimation process: the estimation of hedonic price function and the construction of the inverse demand
function. Now, as any price function would involve maximizing utility subject to income constrains, we have

max U (x, qi , Si , Ni , Li )

s.t.M = Pi + x
where, x, qi , Si , Ni and Li respectively are composite good vector, vector of location specific environment
characteristics, vector of structural characteristics, vector of social and neighbourhood characteristics and
vector of location specific characteristics. And in the second equation M is the household income while Pi is
the price of house i. So, the marginal willingness to pay (MWTP) for changes in, say, qi will be

∂U /∂qi ∂Pi
=
∂U /∂x ∂qi

The hedonic price function for house i will be

Pi = P (qi , Si , Ni , Li )

Since this document has no use for the inverse demand function we will not indulge into the second stage of
the hedonic analysis, i.e. inverse demand function estimation.

Literature Review
The general framework of spatial hedonic model follows from the usual micro economic concept of maxi-
mizing utility given the income constrain, this provides MWTP for estimating the hedonic price equation
(Anselin and Lozano-Gracia (2009)).

Anselin (2006) defines spatial econometrics as “sub-set of econometric methods that is concerned with spatial
aspects present in cross-sectional and time series observations”.

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It is important to account for the spatial dynamics of hedonic house pricing, as inconsistent and biased
estimators obtained without considerations for spatial dependence and spatial heterogeneity could lead to
wrongful implication of government policies (Ottensmann et al. (2008)). Most common example is assess-
ment of property model for tax purposes.

Palmquist and Smith (2001), noted that MWTP for air pollution free environment impelled buyers to
relocate, this lead to changes being made in environmental policies. Such trends were also observed with
respect to water pollution and hazardous wastes.

Spatial hedonic models have not only proven useful at policy implementation, but also in environmental
litigation.

Motivation

Inducing from the concept, that fluctuations in economy or environment affects the price of the most basic
yet indispensable necessities, house price dynamics too, can be an indicator of economic or environmental
shifts, in turn acting as a macroeconomic indicator for possible changes in government policies.

Methodology

Spatial Hedonic model focus on two forms of spatial effects spatial dependence and spatial heterogeneity
which are motivated by the concerns, namely substantive and nuisance (Anselin and Lozano-Gracia(2009)).
Omitting substantive effects when they should be included results in model misspecification. Con-
sequently, the estimates of the remaining parameters will be biased and inconsistent, and inference
may be spurious. On the other hand, nuisance effects are primarily a problem of efficiency. Ig-
noring these effects when present will lead to biased t-tests and misleading indications of precision.
The following models have been in use to account for the above effects.

Spatial lag model

Spatial dependence of a dependent variable is accounted for by inclusion of product of spatial auto regressive
coefficient, spatial weight matrix and the dependent variable on the right hand side of the linear regression
equation, so it becomes
y = ρW y + Xβ + u,
where, y is n x 1 observation vector, ρ is the spatial auto regressive coefficient, W is n x n spatial weights
matrix, β is k x 1 regression coefficient vector, X is n x k explanatory variable matrix and u is n x 1 error
vector. The above equation is, most commonly, regressed using instrumental variable or spatial two stage
least square methods.

Spatial error model

Unobserved spatial effects are shared by those houses which are in the neighbourhood and this leads to
spatially correlated error terms.
V ar[uu0 ] = E[uu0 ] = Σ,
so the regression equation becomes

y = Xβ + ,

 = λW  + u,

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where u follows i.i.d. and λ is spatial auto regressive coefficient. Thus the error variance-covariance matrix
will be
E[0 ] = σ 2 [(I − λW )(I − λW 0 )]−1
The estimation method used for the regression of the above are ML principle and GMM.

In practice, it is usually difficult to determine which of the spatial effects is causing inconsistency, thus it
is difficult to determine which model to use. One of the tests for these kind of situations is spatial Chow test.

The methodology thus used here is,

1. Estimation of the spatial hedonic price equation.

2. Spatially comparing income distribution to spatial house price distribution.

3. Determining the significance of the housing price as indicator, using Wald’s Chi-squared test.

Database
Data to estimate the hedonic price equation is obtained from Open Government Data (OGD) Platform,
India, provided by Commissionerate of Municipal Administration, Tamil Nadu.
And data for comparing income inequality is from IndiaStat, provided by Government of Tamil Nadu.

The database used is of Erode district of Tamil Nadu, primarily agriculture related in nature. Though
now a shift can be observed from the primary sector, the primary occupation in Erode is agricultural and
textile based. After all Erode is know as the “Turmeric City”.

Expected Conclusion
The regression coefficient of income distribution and price distribution should be significant and positive.

References
1. Anselin, L., Lozano-Gracia, N. (2009). Spatial hedonic models. In Palgrave Handbook of Econometrics:
Volume 2: Applied Econometrics pp. 1213-1250
2. Anselin, L. (2006). Spatial Econometrics. In T.C. Mills and K. Patterson, eds., Palgrave Handbook of
Econometrics: Volume 1, Econometrics Theory. Basingstoke: Palgrave Macmillan, pp. 901-941.
3. Osland, Liv. (2010). An Application of Spatial Econometrics in Relation to Hedonic House Price
Modeling. Journal of Real Estate Research. pp 289-320.
4. Palmquist, R. B., Smith, V. K. (2001). The use of hedonic property value techniques for policy and
litigation. In International Yearbook of Environmental and Resource Economics, Volume VI.

5. Ottensmann, J. R., Payton, S., Man, J. (2008). Urban Location and Housing Prices within a Hedonic
Model. Journal of Regional Analysis and Policy, Mid-Continent Regional Science Association, vol.
38(1).