Authors: David Rey Blanco, Pelayo Arbués, Fernando A. López, Antonio Páez
Identifying market segments can improve the fit and performance of hedonic price models. In this paper, we present a novel approach to market segmentation based on the use of machine learning techniques. Concretely, we propose a two-stage process. In the first stage, classification trees with interactive basis functions are used to identify non-orthogonal and non-linear submarket boundaries. The market segments that result are then introduced in a spatial econometric model to obtain hedonic estimates of the implicit prices of interest. The proposed approach is illustrated with a reproducible example of three major Spanish real estate markets. We conclude that identifying market sub-segments using the approach proposed is a relatively simple and demonstrate the potential of the proposed modelling strategy to produce better models and more accurate predictions.