Analysis of spatial variance clustering in the hedonic modeling of housing prices

ABSTRACT This paper examines the spatial dependency exhibited by the error term variance of hedonic modeling based on German housing price data. To this end, it applies the spatial autoregressive conditional heteroscedasticity (SARCH) model previously discussed in housing literature, which allows for the consideration of spatial dependency when modeling the error variance of hedonic pricing. This model represents a spatialized version of the well-known ARCH-model used in time series analysis. Consistent with previous findings, this paper confirms the existence of spatial conditional heteroscedasticity, i.e. dependency in the error variance. However, this spatial dependency is not a global phenomenon, but can be ascribed to spatial concentrations of apartments with a relatively high variance in a small number of the same neighborhoods. The analysis of spatial heteroscedasticity helps to improve the estimation efficiency and prediction accuracy. In addition, spatial differences can be used to account for idiosyncratic risk when conducting mass appraisal.