economics Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behaviour and intera ...

, hedonic regression, also sometimes called hedonic demand theory, is a

revealed preference Revealed preference theory, pioneered by economist Paul Anthony Samuelson in 1938, is a method of analyzing choices made by individuals, mostly used for comparing the influence of policies on consumer behavior. Revealed preference models assume t ...

method for estimating

demand In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given time. The relationship between price and quantity demand is also called the demand curve. Demand for a specific item ...

value Value or values may refer to: Ethics and social * Value (ethics) wherein said concept may be construed as treating actions themselves as abstract objects, associating value to them ** Values (Western philosophy) expands the notion of value beyo ...

. It decomposes the item being researched into its constituent characteristics, and obtains estimates of the contributory value for each. This requires that the composite good (the item being researched and valued) ''can'' be reduced to its constituent parts and that those resulting parts are in some way valued by the market. Hedonic models are most commonly estimated using

regression analysis In statistical modeling, regression analysis is a set of statistical processes for estimating the relationships between a dependent variable (often called the 'outcome' or 'response' variable, or a 'label' in machine learning parlance) and one ...

, although some more generalized models such as sales adjustment grids are special cases which do not. An attribute vector, which may be a dummy or panel variable, is assigned to each characteristic or group of characteristics. Hedonic models can accommodate non-linearity, variable interaction, and other complex valuation situations. Hedonic models are commonly used in

real estate appraisal Real estate appraisal, property valuation or land valuation is the process of developing an opinion of value for real property (usually market value). Real estate transactions often require appraisals because they occur infrequently and every pro ...

real estate economics Real estate economics is the application of economic techniques to real estate markets. It tries to describe, explain, and predict patterns of prices, supply, and demand. The closely related field of housing economics is narrower in scope, conc ...

and

Consumer Price Index A consumer price index (CPI) is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time. Overview A CPI is a statistica ...

(CPI) calculations. In CPI calculations, hedonic regression is used to control the effect of changes in product quality. Price changes that are due to substitution effects are subject to hedonic quality adjustments.

Hedonic models and real estate valuation

In real estate economics, Hedonic regression is used to adjust for the issues associated with researching a good that is as

heterogeneous Homogeneity and heterogeneity are concepts often used in the sciences and statistics relating to the uniformity of a substance or organism. A material or image that is homogeneous is uniform in composition or character (i.e. color, shape, siz ...

, such as buildings. Because individual buildings are so different, it is difficult to estimate the demand for buildings generically. Instead, it is assumed that a house can be decomposed into characteristics such as its amount of bedrooms, the size of its lot, or its distance from the city center. A hedonic regression equation treats these attributes (or bundles of attributes) separately, and estimates prices (in the case of an additive model) or elasticity (in the case of a log model) for each of them. This information can be used to construct a price index that can be used to compare the price of housing in different cities or to do time series analysis. As with CPI calculations, Hedonic pricing can be used to correct for quality changes in constructing a housing price index. It can also be used to assess the value of a property, in the absence of specific market transaction data, and to analyze the demand for various housing characteristics, as well as housing demand in general. Due to the macro-oriented nature of hedonic models, with regard to their more general approach to assessment when compared to the more exacting and specific (albeit less contextualized) approach of individual assessment, when used for mass appraisal, the

Uniform Standards of Professional Appraisal Practice Uniform Standards of Professional Appraisal Practice (USPAP) can be considered the quality control standards applicable for real property, personal property, intangible assets, and business valuation appraisal analysis and reports in the United Stat ...

, or USPAP, has established mass appraisal standards to govern the use of hedonic regressions and other automated valuation models when used for

Hedonic models outside of real estate valuation.

Aside from its use in housing market estimations, Hedonic regression has also seen use as a means for testing assumptions in spatial economics, and is commonly applied to operations in tax assessment, litigation, academic studies, and other mass appraisal projects. Appraisal methodology more or less treats hedonic regression as a more statistically robust form of the

sales comparison approach The sales comparison approach (SCA) relies on the assumption that a matrix of attributes or significant features of a property drive its value. For examples, in the case of a single family residence, such attributes might be floor area, views, locat ...

, making it a popular means for assessment in any market or economic sector in which valuation between two categorically similar (or same) goods (such as two different kitchenware sets) can differ greatly based on additional factors (such as whether the pots and pans made of copper, cast iron, stone, etc, or what non-stick coating, if any, was applied) or constituent goods (including a steamer basket for one of the pots or having the largest pot be a Dutch oven) that strongly influence or semi-exclusively determine the unified good's value.

Criticisms of hedonic models

Some commentators, including

Austrian economists The Austrian School is a heterodox school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result exclusively from the motivations and actions of individuals. Austrian school ...

, have criticized the US government's use of hedonic regression in computing its CPI, fearing it can be used to mask the "true" inflation rate and thus lower the interest it must pay on

Treasury Inflation-Protected Securities United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Since 2012, U.S. gov ...

(TIPS) and

Social Security Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specificall ...

cost of living adjustments. The same use of hedonic models when analyzing consumer prices in other countries, however, has shown that non-hedonic methods may ''themselves'' misstate inflation over time by failing to take quality changes into account.See, for example,

Hedonic models and real estate valuation

Hedonic models outside of real estate valuation.

Criticisms of hedonic models

See also

References

Further reading