House Price Models for Banking and Insurance Applications: The Impact of Property Characteristics

Abstract

Abstract House price indices are needed to assess house price risk in households’ portfolio allocation decisions and in many housing-related financial products such as reverse mortgages, mortgage insurance and real estate derivatives. This paper first introduces nine widely-used house price models to the insurance, risk management and actuarial literature and provides new evidence on the relative performance of these models. We then show how portfolio-level house price indices for properties with specific physical and locational characteristics can be constructed for these different models. All analyses are based on a large dataset of individual property transactions in Sydney, Australia, for the period 1971-2011. The unrestricted hedonic model and a hybrid hedonic repeat-sales model provide a good model fit and reliable portfolio-level house price indices. Our results are important for banks, insurers and investors that have exposure to house price risks.