Handbook of Environmental Economics

Chapter 16

PROPERTY VALUE MODELS

RAYMOND B. PALMQUIST

Department of Economics, North Carolina State University, Raleigh, NC 27695-8110, USA

Contents

Abstract 764

Keywords 764

1. Introduction 765

2. Theoretical models and welfare measurement 766

2.1. The theory of consumer behavior in markets for differentiated products 766

2.1.1. Discrete choice models 772

2.2. Theory of hedonic welfare measurement 774

2.2.1. Localized externalities 774

2.2.2. Nonlocalized externalities without moving 775

2.2.3. Nonlocalized externalities with moving 782

2.3. Differentiated factors of production and land markets 783

3. Estimating the hedonic price schedule 783

3.1. Extent of the market 784

3.2. Stability over time 785

3.3. Functional form 785

3.4. Nonparametric and semiparametric estimation 786

3.5. Measurement of the environmental variables 789

3.6. Other specification issues 790

3.7. Spatial econometric techniques 791

3.8. Rental prices vs. asset prices 794

3.9. Timing of environmental impacts 795

3.10. Repeat sales 796

3.11. Search costs and time on the market 797

4. Estimating the demand for environmental quality 798

4.1. Identification 798

4.2. Endogeneity 800

5. Discrete choice models 802

5.1. Random utility models 802

5.2. Random bidding models 806

6. Locational equilibrium models 808

Handbook of Environmental Economics, Volume 2. Edited by K.-G. Mäler and J.R. Vincent

© 2005 Elsevier B.V. All rights reserved

DOI: 10.1016/S1574-0099(05)02016-4

764 R.B. Palmquist

7. Conclusions and directions for future research 810

Acknowledgements 811

Appendix A 811

References 813

Abstract

One of the only places where environmental quality is traded on explicit markets is real

estate. There are several techniques that can be used to study the effects of environmen-

tal quality on property values and infer willingness to pay for improvements. The most

commonly used method is the hedonic model. In environmental economics the hedonic

model has mainly been applied to the prices of real property and to wages. It assumes

that there is a schedule of prices for the differentiated product (i.e., houses) that can be

estimated. An alternative set of models postulates that consumers’ choices are discrete

between houses rather than continuous in characteristics as in the hedonic model. Dis-

crete choice models are applied to estimate consumer preferences. Recently a model

has been developed that mixes discrete and continuous decisions and emphasizes the

locational equilibrium.

This chapter reviews these techniques, with an emphasis on methodological issues

and recent developments. Section 2 describes the theoretical models that underlie these

techniques. The theoretical hedonic model is developed first, and then the theoretical

modifications that are necessary for the discrete choice models are described. The main

models are developed for residential properties, but differentiated factors of production

are discussed briefly. Section 3 is devoted to the empirical issues involved in estimat-

ing a hedonic price schedule. This is the most common type of estimation in property

value models. Section 4 discusses the empirical application of the second stage of the

hedonic model, the estimation of the underlying preferences. Section 5 covers the two

types of discrete choice models that are used in environmental economics, random util-

ity models and random bidding models. Section 6 briefly discusses the new locational

equilibrium models, and the final section is devoted to conclusions and directions for

further research.

Keywords

property value, hedonic, revealed preference, benefit measurement, differentiated

product

JEL classification: Q51, R21, C31