House Price Dynamics and Market Fundamentals: The Parisian Housing Market

Abstract

The paper compares two methods to evaluate the effect of market fundamentals on housing price dynamics. The first method follows the traditional two-step procedures found in the literature in which one first estimates a house price index and then uses the estimated index in subsequent structural modelling. The second method applies a Kalman filter strategy that allows for the simultaneous estimation of the parameters of a dynamic hedonic price model, the price index and the parameters of a structural model for housing prices. Very similar empirical results are found for the two estimation strategies suggesting that the small efficiency gains of the simultaneous estimator may be outweighed by the relative ease of implementing the traditional methods. Using transaction-level data for dwellings in Paris over the period 1986-92, the paper finds evidence consistent with the hypothesis that economic fundamentals constrain movements in Parisian dwelling prices over longer-term horizons. Both procedures for estimating an error correction model of housing prices based on supply and demand fundamentals lead to the same conclusions, suggesting that the speed of adjustment in the Paris dwelling market was about 30 per cent per month over the period.