HEDONIC METHOD (IN COMPILATION OF CONSTRUCTION PRICE INDICES)

 Definition: The hedonic method in the compilation of construction price indices entails the use of regression techniques to construct hedonic indices to measure purchasers’ preferences for the different characteristics of construction work. This approach, which is used in the compilation of some of the price indices compiled in the Netherlands, Sweden and the United States, starts from the premise that each construction is a combination of characteristics, each of which has an implicit price. This price is set by the market and is reflected in the over-all prices for which different combinations of these characteristics are sold, and where different varieties of the same construction type, each with its own peculiar combination of characteristics, co-exist.

 Context: In addition to total price a limited number (7 to 15) of characteristics (qualitative or quantitative) are taken into account. For a house, possible characteristics include: floor area, number of floors, type of garage, method of heating, number of toilets, etc.Using econometric techniques (regression and covariance analysis) weight of each of these characteristics in determining the price is estimated. These weights can then be used to factor out that part of the price change in the next month which is due to changes in the characteristics of the house, etc. sold. The coefficients of the regressions are calculated first by means of total construction price information and their characteristics in the current year, and on the basis of information on the same type for a base period. Each construction during the current period is priced at what it would have cost during the reference period, once its characteristics are known. Indices are calculated from current prices and then aggregated using either Laspeyres formula if the values of the characteristics are taken from the base period, or Paasche if they are taken from the current period.The problem with this method, which is based on just a few elements of construction, is that it is less discerning than the schedule of prices method in detecting qualitative change. If construction quality is enhanced the improvement will tend to be underestimated and thus the actual increase in prices overestimated.Furthermore, the use of these techniques requires the statistical agency to have access to trained econometricians, as well as specialist knowledge of the construction industry.

 Source Publication: Sources and Methods: Construction Price Indices, OECD + likeforex.com/glossary.

 Cross References: Construction price indices Subsequent breakdown methods (construction price indices)