Volume-related heteroskedasticity and liquidity premium in hedonic pricing model

Abstract

Volume of transaction plays two roles in a market, first, it is related to liquidity of assets; second, it affects information cost in the price discovery process. The former results in a liquidity premium on price, which is a first moment effect of hedonic price; the latter produces price dispersion, which causes heteroskedasticity of error terms (the second moment) of hedonic price. This study tests empirically on these volume-related liquidity premium and heteroskedasticity in a panel sample of housing. The sample consists of more than 1600 transactions in 1999 of various housing developments in a small area in Hong Kong is studied. The results agree with our postulations that (1) relative liquidity imposes a positive premium on housing price; and (2) the magnitude of error terms in the hedonic pricing analysis is negatively related with the transaction volume in the previous 30-day in the same estate. The hedonic pricing model is re-estimated by an iterative generalized least squares (GLS) approach with volume-effect weighting. The efficiency of the estimation is greatly improved and a homoskedastic estimation is obtained. © 2006 Taylor & Francis.