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Hedonic Models with Redevelopment Options under Uncertainty
Author(s) -
Clapp John M.,
Jou JyhBang,
Charlene Lee Tan
Publication year - 2012
Publication title -
real estate economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.064
H-Index - 61
eISSN - 1540-6229
pISSN - 1080-8620
DOI - 10.1111/j.1540-6229.2011.00323.x
Subject(s) - economics , economic rent , econometrics , variance (accounting) , value (mathematics) , term (time) , unit (ring theory) , microeconomics , mathematics , statistics , physics , mathematics education , accounting , quantum mechanics
In the hedonic model, implicit market prices can be interpreted as the present values of rents per unit of each hedonic characteristic. But when rents rise, there may be substantial value associated with the option to redevelop to higher intensity per unit land value. In the presence of option value, we first demonstrate that hedonic linear regressions should include an additive nonnegative term for the value of the option. This term increases in the variance of the underlying stochastic process. If this term is omitted, then estimates of implicit market prices for desirable (undesirable) characteristics will be biased downward (upward). This prediction is supported by recent empirical studies. We further suggest that future empirical work can employ the nonlinear functional form derived from our theory.