Journal of Real Estate Finance and Economics, 28:2/3, 161±178, 2004
# 2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
Selectivity, Quality Adjustment and Mean Reversion in
the Measurement of House Values*
National University of Singapore, Singapore
JOHN M. QUIGLEY
University of California, Berkeley, CA, U.S.A.
This paper develops a model of price formation in the housing market which accounts for the non-random
selection of those dwellings sold on the market from the stock of existing houses. The model we develop also
accounts for changes in the quality of dwellings themselves and tests for mean reversion in individual house
prices. The model is applied to a unique body of data representing all dwellings sold in Sweden's largest
metropolitan area during the period 1982±1999. The analysis compares house price indices that account for
selectivity, quality change and mean reversion with the conventional repeat sales models used to describe the
course of metropolitan housing prices. We ®nd that the repeat sales method yields systematically large biased
estimates of the value of the housing stock. Our comparison suggests that the more general approach to the
estimation of housing prices or housing wealth yields substantially improved estimates of the course of housing
prices and housing wealth.
Key Words: house price index, selectivity, mean reversion, hybrid model
Owner-occupied housing is a substantial fraction of aggregate wealth in most advanced
countries. For example, in the United States in 1982, the aggregate value of owner-
occupied housing, $2.8 trillion, exceeded the value of all ®nancial wealth held by the
$2.0 trillion (Case et al., 2001). It was not until 1993 that household
ownership of ®nancial wealth in the United States equaled ownership of housing wealth
(about $6.2 trillion). Even after the massive run-up in share prices in the late 1990s, it is
still the case that aggregate house values are more than 40 percent of household ®nancial
Despite the size and importance of housing wealth, its magnitude is measured much less
*A previous version of this paper was presented at the Third Cambridge-Maastricht Conference on Real Estate
Finance and Investment, Maastricht, June 2002.