Buy to Scrape? The Hedonic Model with Redevelopment Options

41 Pages Posted: 3 Dec 2007 Last revised: 16 Jun 2009

See all articles by John M. Clapp

John M. Clapp

University of Connecticut - Department of Finance

Jyh-Bang Jou

National Taiwan University

Tan Lee

Yuan-Ze University

Date Written: May 12, 2009

Abstract

In Rosen’s (1974) 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 the bundle of characteristics to higher intensity. In the presence of option value, hedonic regressions should include an additional non-negative term for the value of the option. If this option term is omitted, then estimates of implicit market prices for a positively valued characteristic will be biased downward. We use simulations to compare the standard hedonic regression to a nonlinear regression designed to produce consistent estimators of implicit prices and to estimate the value of the redevelopment option. The simulations show substantial downward bias even in the presence of small amounts of option value. Moreover, nonlinear estimation can do a good job of recovering the amount of option value and estimates of implicit market prices.

Keywords: real options value, hedonic model, nonlinear regression, valuation, human capital, real estate

JEL Classification: C8, D4, D81, E22, R11

Suggested Citation

Clapp, John M. and Jou, Jyh-Bang and Lee, Tan, Buy to Scrape? The Hedonic Model with Redevelopment Options (May 12, 2009). Available at SSRN: https://ssrn.com/abstract=1048801 or http://dx.doi.org/10.2139/ssrn.1048801

John M. Clapp (Contact Author)

University of Connecticut - Department of Finance ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States
860-486-5057 (Phone)
860-486-0349 (Fax)

Jyh-Bang Jou

National Taiwan University ( email )

1 Sec. 4, Roosevelt Road
Taipei 106, 106
Taiwan

Tan Lee

Yuan-Ze University ( email )

135 Far-East Rd., Chung-Li 320
Taipei
Taiwan

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