The term “hedonic” refers to the concept that the value of a home can be determined by looking at the value of the constituent components of a home. A hedonic index is any price index that uses information from hedonic regression, which describes how product price could be explained by the product’s characteristics. Hedonic regressions are used for property price index measurement to control for changes in the quality-mix of properties transacted. Hedonic pricing is a model that identifies price factors according to the premise that price is determined both by internal characteristics of the good being sold and external factors affecting it. It only captures a consumer’s willingness to pay for what they perceive are environmental differences.
“The hedonic index model has many advantages, including the ability to estimate values, based on concrete choices, particularly when applied to property markets with readily available, accurate data.”
A hedonic pricing model is often used to estimate quantitative values for environmental or ecosystem services that directly affect market prices for homes. Hedonic price indexes have proved to be very useful when applied to calculate price indices for information and communication products (e.g. personal computers) and housing because they can successfully mitigate problems such as those that arise from there being new goods to consider and from rapid changes of quality. Because a hedonic approach is based on a holistic view of all the data available, it is not inherently skewed by the mix shifting to larger (or smaller) properties. This method of valuation can require a strong degree of statistical expertise and model specification, following a period of data collection. Due to the significant impact that real estate prices may have on overall economic developments, it is necessary to create a reliable index for monitoring the movements of real estate prices.
The hedonic quality adjustment refers to a method of adjusting prices whenever the characteristics of the products included in the CPI change due to innovation or the introduction of completely new products. Hedonic pricing identifies the factors and characteristics that affect an item’s price. Hedonic pricing is most often seen in the housing market, wherein the price of a piece of real estate is determined by the characteristics of the property itself.
The hedonic index model has many advantages, including the ability to estimate values, based on concrete choices, particularly when applied to property markets with readily available, accurate data. It also has significant drawbacks, including its ability to only capture consumers’ willingness to pay for what they perceive are environmental differences and their resulting consequences.