# **1. Introduction**

Attributing values to the flow of services households derive from their dwellings, such as rental values, is a knotty issue that recurs in various contexts, including the compilation of national accounts (Heston 1994), the estimation of consumer price indexes (CPIs) (Lebow and Rudd 2003), the compilation of purchasing power parity indexes (Deaton and Heston 2010), and the analysis of poverty and inequality (Balcazar et al. 2017; World Bank 2020). The key problem is calculating rental values for those households that do not rent their dwellings because they own the dwellings or, for instance, because the dwellings are provided free by relatives or employers. In such cases, the rental values must be estimated.

Despite the prominence of the issue in various contexts, the jury is still out on the best practice for imputing rental values across homeowners. Three main approaches to rent imputation are typically adopted in the literature: hedonic models, nonhedonic models (the rent-to-value approach, the user-cost approach, and the rental equivalence approach), and self-assessment. The hedonic theory of consumption implies that the implicit prices of goods are a function of the characteristics of the goods (Lancaster 1966). Hence, rents reported by tenants are estimated econometrically as a function of the observable characteristics of the dwellings, and the parameters are used to predict implicit rents across homeowners.

In nonhedonic models, the second approach, the implicit rent is understood as the rate of return that would have been obtained by an owner if the equity in the home had been invested in an interest-bearing account. (See Balcazar et al. 2017, for a comprehensive review of imputation methods, ranging from parametric to nonparametric models, including rent-to-value and user-cost approaches.) The third approach relies on homeowners’ subjective evaluations of the market rental values of their residences. This method has been widely used. For example, half the 21 economies in the Asia and Pacific region that participated in the International Comparison Program for the computation of 2011 purchasing power parities use self-assessed rental values to impute rents going to homeowners (ADB 2014). The African Development Bank also presents equivalent results for countries that include rents in national accounts: half the countries use self-assessment (AfDB 2013). The weights of the CPI in the United States are computed based on the values of dwellings found in the Consumer Expenditure Survey. The rental values of owner-occupied dwellings revealed in the survey depend on owner estimates (Lebow and Rudd 2003). According to a recent review of national methodologies used to produce official poverty estimates (World Bank 2020), poverty estimates in 16 percent of the countries surveyed include rental values that are self-assessed by homeowners.

Using homeowner assessments relies on the assumption that homeowners can give an accurate estimate of the rental market values of their dwellings, perhaps with the help of interviewers, as suggested by Garner and Kogan (2007). This information is frequently collected in household budget surveys, in which homeowners are often asked to estimate the rents they would pay to live in their current dwellings. However, owner-occupiers may not be able to provide accurate estimates of the rental prices for their dwellings, and the direction and magnitude of the inaccuracies become an empirical issue. In countries in which rental markets are thin because of high rates of homeownership, one may reasonably expect that homeowners might merely lack information about rental prices. In other circumstances, homeowners might overestimate the true rental values of their dwellings compared with rented dwellings having similar characteristics because of their attachment to specific features of their neighborhoods or of their residences, particularly if they designed or built the homes (Frick et al. 2010; Heston and Nakamura 2009). Extensive evidence on the United States suggests that self-assessed rental 2