Pricing Characteristics: An Application of Shephard’s Dual Lemma

Abstract

The recent housing bubble has provided impetus for revisiting indicators of housing price inflation and property characteristics. Diewert (2011, Alternative Approaches to Measuring Housing Price Inflation, paper presented at the Economic Measurement Group Workshop, 2011, UNSW, Australia) for example has provided a comparison of various methods of constructing property price indices using index number and hedonic regression methods, which he illustrates using data from a small Dutch town over a number of quarters. We provide an alternative approach based on Shephard's dual lemma and apply it to the same data used by Diewert. This method avoids the multicollinearity problem associated with traditional hedonic regression, and the resulting prices of property characteristics show smoother trends than Diewert's results. We also revisit the Diewert and Shimizu (2013) study that employed hedonic regressions to decompose the price of residential property in Tokyo into land and structure components and that constructed constant quality indexes for land and structure prices respectively. We use three models from Diewert and Shimizu (2013) to fit our real estate data from town "A" in Netherlands, and also construct the price indices for land and structure, which are compared with our results derived above.