Hedonic Regressions. A Consumer Theory Approach

Abstract

A hedonic regression regresses the price of various models of a product (or service) on the characteristics that describe the product. The existing economic theory that justifies a hedonic regression is extremely complex. The present paper takes a very simple consumer theory approach in order to justify a family of functional forms for a hedonic regression. The main simplifying assumption is that every consumer has the same hedonic utility function, which describes how consumers evaluate alternative models with different characteristics. This hedonic utility function is assumed to be separable from other goods, which is the second main simplifying assumption. The paper also examines alternative functional forms for the hedonic utility function from the viewpoint of their flexibility properties; i.e., how well they can approximate arbitrary functional forms. The paper notes that hedonic regressions that regress the model price on a linear function of the characteristics is not consistent with the consumer approach adopted in the paper. Finally, the paper compares traditional statistical agency matched model techniques for dealing with quality change with the hedonic regression approach and indicates under what conditions the two approaches are likely to coincide.