Where Case-Shiller Got it Wrong: The Effect of Credit Supply on Price Indices

Abstract

We develop a version of the The Case-Shiller Index that is robust to credit supply. We first argue that changing financial conditions can affect the market composition and demand for housing, resulting in mismeasured price indices. Second we quantify the causal effects of changes in interest rates and underwriting standards on prices and market composition within each city. Third, we correct for this bias by introducing the locally-weighted repeat sales technique, a novel estimation procedure for estimating a distinct price index for any given asset; by aggregating the results we can define a new properly measured index. Finally, we highlight the advantage of our technique by examining the US housing market. By matching transaction-level data with household credit data we find that loosening underwriting standards for low income households drove strong demand and high turnover in low tier housing. As a result of these changing market conditions, Case-Shiller overstates the peak of the housing bubble by 20% in the Los Angeles Market and understates the decline by nearly half in Cleveland.

Keywords: House Price Measurement, Repeat-Sales, Credit Supply

JEL Classification: R30, R31