Essays on the price behavior of the real estate market

This dissertation investigates the methodologies for constructing housing price indices, estimating serial correlation of housing market returns, and pricing mortgage default options. The proposed methodologies are applied to data on individual sales from 1970-86 in Atlanta, Chicago, Dallas and San Francisco.; Several repeat sales models have been advanced over the years for estimating real estate price indices. Chapter 2 proposes a two-error AR(1) model of city-wide housing price, which incorporates earlier models as special cases and compares the alternative repeat sales models using posterior odds ratios as criteria. In general, the two-error term models outperform the one-error models. There is significant discrepancy among the indices obtained from different models.; In chapter 3, a two-step two-sample method and a Bayesian method are proposed to estimate the serial correlation and the seasonality of the price behavior of the residential housing market. The Bayesian method is found superior to alternative two-step methods. The empirical results based on the Bayesian approach support the rejection of the random walk hypothesis in the four metropolitan housing market.; The mortgage pricing literature typically assumes that house prices evolve according to a geometric Brownian motion; the literature then employs conventional arbitrage arguments to value mortgages and their imbedded default options. However, this is not a realistic approach to the modeling of the real estate market. In Chapter 4, we propose a method of polynomial approximation to value the mortgage default option. This methodology does not rely on arbitrage arguments. Rather than assuming the house price to be a random walk process, we use an empirically estimated house price model to value the default option. We show that variation in the forecastable returns can produce significant variation in the mortgage default option price. Using the above data, serial correlation of the market return is found to have strong impacts on the price of the default option in all four cities.