THE INFLUENCE OF ECONOMIC VARIABLES ON LOCAL HOUSE PRICE DYNAMICS

This paper is motivated by recent studies of the effect of economic ch anges (e.g., in population, employment, and income) on house prices (s ee Mankiw and Weil, Regional Science and Urban Economics, 19, 235-258, 1989; Hendershott and Peach draft paper presented at the AREUEA midye ar meeting in Washington, DC, 1990; DiPasquale and Wheaton draft paper presented at the AREUEA midyear meeting in Washington, DC, 1990). The purpose of this study is to explore the relationship between methods used to measure house price indices and economic determinants of house prices at the local level. Non-nested tests proposed by Davidson and MacKinnon (Econometrica, 49(3), 781-793, 1981) and by Green (Economic Letters, 31, 349-354, 1989) are extended to deal with contemporaneous correlation among disturbance terms. Also, a new chi2 test is develope d to evaluate differences in the functional relationships between alte rnative house price indices and economic variables. Twomethods for mea suring house price changes are used: the repeat sales method and the a ssessed value (AV) method. Data for Hartford, Connecticut, indicate th at the correlation between the annual rates of change in these two pri ce indices is high (about 0.8). But the percentage changes in the two price indices differ substantially over periods of 2 to 10 quarters. N evertheless, the two price indices are related to economic variables, such as changes in local employment and unemployment, in a similar way . The results indicate a strong role for expected inflation and unempl oyment, both of which reduce house price changes. Furthermore, these v ariables have considerable forecasting ability, contrary to the effici ent market hypothesis. Model results could be improved by combining AV and repeat price indices with about twice as much weight on the AV me thod. (C) 1994 Academic Press, Inc.