Hedonic Pricing with Redevelopment Options: A New Approach to Estimating Depreciation Effects

Abstract

The standard hedonic model of durable assets is a special case of a more general model that contains two additive terms: 1) use value of the existing hedonic vector and 2) the value of the option to reconfigure hedonic characteristics. One empirical implication is that the two parts of value are related: e.g., use value increases with interior area whereas option value decreases with “intensity,” the ratio of structure value divided by land value. Increases in building age reduce use value but increase option value. Data from Greenwich Connecticut indicate that intensity has the expected negative effect. Coefficients on building age are shown to be better measures of depreciation when intensity variables are included in the regression.

Keywords: real options, hedonic pricing models, depreciation, age effect, option to redevelop

JEL Classification: D120, D460, G130, R310