Calculating Hedonic Price Indices with Unobserved Product Attributes: An Application to the UK Car Market

We show that hedonic price indices that omit model-specific unobservable product attributes are subject to considerable bias. We utilize a complete panel of new car versions marketed in the UK over 1971-98 which incorporates over 100 observable product characteristics, sales weighting to capture the distribution of purchases across models, and model-specific fixed effects to account for unobservable characteristics. We find that quality-adjusted prices obtained from hedonic regressions that do not account for unobservable characteristics exhibit a severe downward bias. We also show that quality-adjusted prices exhibit distinct sub-market differences having increased in 'mass production' segments and decreased in 'specialized niches'. Copyright (c) The London School of Economics and Political Science 2006.

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