SPATIAL DEPENDENCE AND HOUSE PRICE-INDEX CONSTRUCTION

Accurate estimation of prevailing metropolitan housing prices is impor tant for both business and research investigations of housing and mort gage markets. This is typically done by constructing quality-adjusted house price indices from hedonic price regressions for given metropoli tan areas. A major limitation of currently available indices is their insensitivity to the geographic location of dwellings within the metro politan area. Indices are constructed based on models that do not inco rporate the underlying spatial structure in housing data sets. In this article, we argue that spatial structure, especially spatial dependen ce latent in housing data sets, will affect the precision and accuracy of resulting price estimates. We illustrate the importance of spatial dependence in both the specification and estimation of hedonic price models. Assessments are made on the importance of spatial dependence b oth on parameter estimates and on the accuracy of resulting indices.