Market Risk Factor and the Weighted Repeated Sales Method

Abstract

This paper identifies a critical issue in the Weighted Repeated Sales (WRS) method – the omission of market risk in the weight estimation model specified by Case and Shiller (1989). It demonstrates that the omission of market risk is conceptually unjustified. Through extensive examination of the real estate market risk, the study not only proposes a modified WRS model that is empirically supported, but also contributes to the broad discussion on the term structure of the real estate risk. It also shows that the Case-Shiller weighting method is likely to be misspecified in nine of the ten cities where the Case-Shiller metro indices are "tradable" with housing options and futures contracts listed on the Chicago Mercantile Exchange. Using a large sample of repeated sales from Washington DC area, the original repeated sales method of Bailey, Muth, and Nourse (1963) and the Case-Shiller method are compared against the modified WRS, and the results indicate that market risk plays an important role in the index estimation.

Keywords: Market Risk Factor, Weighted Repeated Sales Method, Home Price Index

JEL Classification: R3