In this paper we address the issue of the robustness of the price level, mean, and variance estimates for two sets of repeat sales real estate price indices: the classical WRS method and a PCA factorial method, as elaborated in Baroni, Barthélémy and Mokrane (2007). We use an extensive repeat sales database for the Paris (France) residential market to compute the parameters of the indices produced over the period 1982-2005. The aim here is to test the sensitivity of these two indices to revision due to additional repeat-sales transactions information. Our main conclusion is that the revision problem may cause serious concern for the stability of key parameters that are used as inputs in the pricing of derivatives contracts. The impact of index revision is important on the estimate of the index price level. We also find that although the revision impact on the trend estimate can be important: the WRS method seems more robust and derivatives contracts such as swaps may be based on such indices. Finally, the revision influence on volatility estimates seems to be less stringent, and according to the robustness of the volatility estimate, the BBM factorial index seems to fare relatively better than the WRS index. Hence, we find that the factorial index could better sustain volatility based derivatives such as call or put options.
BARONI, M., BARTHELEMY, F. and MOKRANE, M. (2007). Is It Possible to Construct Derivatives for the Paris Residential Market? ESSEC Business School.