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The hedonic-price method offers a way of avoiding the quality change, comparability and narrowness problems associated with the first two methods; unfortunately, the data required to estimate a hedonic price model make this method relatively expensive to implement.

Price Sources

Data Filtering

To avoid the problem of including arms length pricing in the calculation of the index, filtering of data would be done. This filtering would be accomplished by taking the log of the price data and eliminating transactions outside two standard deviations from the mean; this process filters out extreme high and low transaction values.

Looking Forward

Recently Chicago Mercantile Exchange announced the launch of S&P CME Housing Futures and Options. The Commercial Real Estate futures and options contracts are based on the GRA Commercial Real Estate Indexes (CREX) TM. These derivatives will enable investors to take a position on the direction of home prices either for the nation as a whole or for 10 major cities to start, including New York, Los Angeles and Chicago.

Due to the heterogeneous nature of real estate assets, as well as the difficulty in selecting a reliable and representative underlying index, real estate markets are the last of the major asset classes not to have a liquid futures market. Risk management tools are notoriously scarce for real estate investors. Until now, there was no way to really hedge residential real estate. The only ways to even bet against the housing market were restricted to commercial or indirect plays on the housing market.

Possible users of real estate index derivative products are:

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* Contributed by: -
Rahul Abrol & Rahul Gulati,
MBA - IInd Year,
Institute of Management Technology, Ghaziabad.