# RECORD a855c4aba93669899f6285712fd4b23cfb3500bb # TITLE: Estimation of a Hedonic House Price Model with Bargaining: Evidence from the Italian Housing Market # YEAR: 2013.0 VENUE: Aestimum DOI: 10.13128/aestimum-13123 # AUTHORS: Mauro Iacobini; G. Lisi # PAGES: 14 CANDIDATE TABLE PAGES (1-based): [11] # ABSTRACT: This empirical paper tests the role of bargaining in the formation process of housing prices in Italy. Housing markets are “thin”, local and decentralized, and thus buyers and sellers may have some market power. Hence, the selling price is influenced both by the characteristics of the product as well as by the bargaining power of the buyers and sellers. Furthermore, the bargaining power of the seller (buyer) can also be viewed as the cost of incomplete information imposed on the buyer (seller). The empirical results derived from multiple regression analysis support our theoretical assumptions. In fact, the variables created as proxies of bargaining power of the parties, and incorporated into the hedonic price function, are statistically significant and help to improve the performance of the hedonic model, thus reducing the differences between predicted and observed selling prices. ===== PAGE 1 (score 2, numeric-paren 0, table-words 0, var-words 2) ===== © Firenze University Press www.fupress.com/ceset XLI Incontro di Studio del Ce.S.E.T.: 41-54 Estimation of a Hedonic House Price Model with Bargaining: Evidence from the Italian Housing Market* This empirical paper tests the role of bargaining in the formation pro- cess of housing prices in Italy. Housing markets are “thin”, local and de- centralized, and thus buyers and sellers may have some market power. Hence, the selling price is influenced both by the characteristics of the product as well as by the bargaining power of the buyers and sellers. Furthermore, the bargaining power of the seller (buyer) can also be viewed as the cost of incomplete information imposed on the buyer (seller). The empirical results derived from multiple regression analysis support our theoretical assumptions. In fact, the variables created as proxies of bargaining power of the parties, and incorporated into the hedonic price function, are statistically significant and help to improve the performance of the hedonic model, thus reducing the differences between predicted and ob- served selling prices. Mauro Iacobini Gaetano Lisi Territorial Agency, Rome E-mail: mauro.iacobini@ agenziaterritorio.it E-mail: gaetano.lisi@ agenziaterritorio.it Key words: Hedonic price theory, bargaining power, asymmetric and incomplete information, multiple regression analysis 1. Introduction The hedonic price theory, traced back to the papers of Lancaster (1966), Rosen (1974), and Epple (1987), is the theory of reference for the housing market. Ac- cording to this theory, the price of a composite good, such as a home, depends on its intrinsic and extrinsic characteristics, whose prices (being implicit or hedonic) are not readily observable but can be revealed to economic agents through the ob- served selling prices of houses and the specific amounts of attributes associated with them (for an exhaustive overview see Sheppard, 1999 and Malpezzi, 2003). Hence, in the standard hedonic price model, only the heterogeneous nature of real estate goods is taken into account, since the selling price is a function of the housing characteristics. According to the price dispersion literature (for a review see Leung, Leong and Wong, 2006), an important part of price volatility cannot be attributed to the heterogeneous nature of real estate goods. In fact, two similar houses (namely, two houses with the same attributes and located close to each other) can be val- ued differently at the same time (Maury and Tripier, 2010). Thus, remaining price differentials may be caused by the heterogeneity of the parties (tastes, preferences, patience, search costs, asymmetric information, etc.).1 * This work is connected to the experimentation activity (year 2011) conducted by the Territorial Agency, Head Office of Real Estate Market Observatory and Appraisal Services, Real Estate ===== PAGE 11 (score 20, numeric-paren 0, table-words 7, var-words 3) ===== Estimation of a Hedonic House Price Model with Bargaining: Evidence from the Italian… 51 5.2. Marginal prices In equation [2a] and [2b], the marginal prices implicitly reflect the effects of bargaining, in the sense that the estimated coefficients are different (or equal by co- incidence) to those predicted in the absence of Γ and Ω. This consideration is very important for property valuation where estimation of the marginal value of an at- tribute is commonly used to adjust comparable sales data. Therefore, if the estimat- ed regression coefficients are used as marginal prices in real estate appraisals (for example, by the Sales Comparison Approach), the price correction will be different us- ing the standard hedonic model rather than the hedonic model with bargaining. Indeed, as regards the variables “location” and “state of building” and with ref- erence to the city of Taranto, a somewhat surprising result emerges: the hedonic prices are systematically overestimated in the standard hedonic model (see Table 3). Table 3. a) “Location” City – zone OMI Model with bargaining Model without bargaining Marginal price p-value Marginal price p-value Taranto – B1 € 9.603,85 0.001 € 12.766,47 0.002 Taranto – C1 € 11.463,41 0.000 € 17.416,52 0.000 Taranto – D1 € 20.538,28 0.000 € 29.548,34 0.000 Taranto – E2 € 5.311,70 0.113 (*) € 7.352,90 0.060 b) “State of building” City – zone OMI Model with bargaining Model without bargaining Marginal price p-value Marginal price p-value Taranto – B1 € 8.340,49 0.000 € 10.216,55 0.002 Taranto – C1 € 6.959,62 0.248 (*) € 12.507,79 0.108 (*) Taranto – D1 € 15.764,46 0.000 € 17.403,33 0.000 Taranto – E2 € 14.109,49 0.008 € 28.117,67 0.000 (*) It means that the marginal price is not significant at the confidence level of 10%. As regards the estimated marginal prices, with the exception of the floor area, the very significant characteristics vary depending on the city and area consid- ered, thus confirming the “local” character of housing markets (see Table 4). Fur- thermore, note that the prevailing orientation is the only variable that is never sta- tistically significant. ===== PAGE 12 (score 15, numeric-paren 0, table-words 1, var-words 13) ===== 52 M. Iacobini, G. Lisi Table 4. Hedonic prices. City – zone OMI Characteristics statistically significant (level of confidence 10%) Alessandria – B1 5: Floor area, Number of balconies, New construction, Architectural style, Quality of view Cosenza – B1 2: Floor area, Number of bathrooms Cosenza – D1 3: Floor area, Architectural style, Quality of view Crotone – D1 4: Floor area, Location, Architectural style, Number of balconies Genova – D43 4: Floor area, Location, Floor level with elevator, Number of balconies Taranto – B1 6: Floor area, Location, New construction, Quality of view, State of building, Floor level with elevator Taranto – C1 5: Floor area, Number of bathrooms, Number of balconies, Location, Quality of view Taranto – D1 4: Floor area, Location, New construction, State of building Taranto – E2 6: Floor area, Number of bathrooms, Number of balconies, New construction, Architectural style, State of building Venezia Mestre – E23 3: Floor area, Quality of view, Number of bathrooms Vercelli B1 7: Floor area, Location, Floor level with elevator, Number of balconies, Architectural style, State of building, Location Vercelli B2 2: Floor area, State of building 6. Conclusions Bargaining is an important part of the price formation process for heteroge- neous goods, such as a home. In fact, housing markets are not perfectly com- petitive and consequently the “true” market price is not readily observable. Un- der these conditions, the selling price is influenced both by the characteristics of the product as well as by the heterogeneity of the parties. Indeed, the bargaining power of the buyers and sellers is a good proxy of the heterogeneity of the par- ties. Furthermore, the bargaining power of the seller (buyer) can also be viewed as the “tax” or cost imposed on the buyer (seller) for having incomplete information. In this paper we find empirical evidence for our theoretical assumptions in the Italian housing market. This result has two main consequences: • First, ignoring bargaining may lead to omitted variable bias on estimated implicit prices in hedonic pricing models. This question is significant for property valua- tion where estimation of the marginal value of an attribute is commonly used to adjust comparable sales data. • Second, bargaining helps improve the performance of the hedonic model, thus reducing the differences between predicted and observed selling prices. This is- sue is significant in making correct predictions regarding housing sale prices. Furthermore, this model may be useful for selecting the comparables most suitable for the Sales Comparison Approach. In fact, it is quite clear that the resi- dential property affected by the bargaining power should be eliminated.