Chris Curington Hedonic pricing

Content What is Hedonic Analysis? Hedonic Price Method - Steps Examples of Hedonic Pricing Conclusions/Discussion

Non-Market Valuation Revealed Stated Direct Indirect market price contingent valuation Indirect Hedonic price contingent ranking Hedonic wage conjoint analysis Travel cost choice experiments Avoidance behavior

What is Hedonic Analysis? Hedonic definition: of, relating to, or characterized by pleasure In economics, this translates to willingness to pay for certain amenities. The basic idea is that property prices are a direct reflection of its attributes (Composite good) Hedonic analysis is a way to reveal preference or WTP for non market goods.

What is Hedonic Analysis? Ex Ante vs. Ex post Linear vs. non-linear Hedonic Property How much more would you pay to live in a “clean” area? Hedonic Wages How much more would you need to be paid to work in a “dirty” city?

What is Hedonic Analysis? Why Use Hedonic Pricing? Revealed vs. Stated Preference No formal markets for public goods Data comes from existing markets (real transactions!) Versatility: This method can be adapted for many ocassions where public goods need to be ascribed a market value.

What is Hedonic Analysis? History Property, Cars, Agriculture, wine 1926 Waugh - Vegetable prices 1938 Court – Detroit Car Market P = 0 +  1Z1 +  2Z2 + ... + t + , Zi are component parts, and t = time trend 1967 Ridker and Henning – Air pollution and the housing market 1974 Rosen – Creates a formal model

Hedonic Pricing: Steps Rosen model Utility function of consumers: U(s,n,c) s = house attributes n = location characteristics c = other consumption goods However, utility maximization is subject to budget constraints: m = c + p(s,n) m = income p(s,n) House expenditure c expense of other goods’ p(s,n) = hedonic price function – the goal is to find how a marginal change in n changes the price.

Hedonic Pricing: Steps Rosen model, continued The budget constraint reflects the utility curves of different consumers, what we don’t spend on other goods, we spend on housing. The consumer’s Utility function: U(s,n,c)=U(s,n,m – p(s,n)) Rosen’s model states that buyers and sellers are “matched” along the hedonic price function. More generally, price is related to the sum of attributes: p(x1,x2,x3,…xn) And marginal change in price: Where β1 is the percent change in price as a result of a change in x1

Hedonic Pricing: Steps To simplify Hedonic property analysis: Step 1: Collect data for a region over time. DATA: prices, locations, property characteristics, neighborhood characteristics, accessibility characteristics, environmental characteristics. This data collection has been made possible in the recent past because of better record keeping, GIS maps, and computer programs to assist in analyzing large data sets. Step 2: Derive a statistical function (regression analysis) which “unbundles” all of the component parts of property values and ascribes a value to each component part. Step 3: Perform the ex post or ex ante cost benefit analysis

Examples of Hedonic Pricing Location attributes Analyzing location attributes with a hedonic model for apartment prices in Donetsk, Ukraine Kryvobokov & Mats Wilhelmsson (2007) Analyzed apartment values considering a polycentric model with positive and negative externalities

Examples of Hedonic Pricing

Examples of Hedonic Pricing Dummy = non-numeric

Examples of Hedonic Pricing Air pollution “The determinants of property values with special reference to air pollution” Graves - Review of Economics and Statistics. Census tract data from 1960s St. Louis *(not individual properties) DV: median property prices IV: median characteristics of houses in a census tracts school quality, taxes, highway accessibility, neighbourhood characteristics, public service quality Air quality effects on houses (human health) (SO2, SO3, H2S, H2SO4)

Examples of Hedonic Pricing House price falls by $245 if pollution exists Ridker and Henning estimate the environmental damage of air pollution in St. Louis to be 82 million dollars and request a CBA to compare this estimate with clean up programs Coefficient Standard Error Air pollution -245.0 88.1 Rooms 488.5 41.1 Distance from city centre (minutes) 320.2 138.7 New buildings (%) 48.36 7.20 Access to highway (dummy) 922.5 278.9 Number of persons in a house -3,210.0 548.7 Median income per family 0.937 0.1057

Examples of Hedonic Pricing Water Quality Effects of Chesapeake Bay water quality on prices of houses located along the bay - Leggett and Bockstael (2000) 741 observations – too low? Use of appraised value of homes – Is this accurate? Water quality levels are determined by the public health department of Maryland

Examples of Hedonic Pricing Variable Description Media N=741 Price ($1000) Sale price 335.91 VSTRU Apprised value of the house 125.84 ACRES House acreage 0.90 ACSQ acreage2 2.42 DISBA Distance from Baltimore 26.40 DISAN Distance from Annapolis 13.30 ANBA DISBA*DISAN 352.50 BDUM DISBA*(% commuters) 8.04 PLOD % of land not intensively developed 0.18 PWAT % of land with water or humid areas 0.32 DBAL Minimum distance from a polluting source 3.18 F.COL Median concentration of fecal coliform 109.70

Examples of Hedonic Pricing Findings Fecal coliform (Bacteria) = -0.052 dollars per 1,000 dollars home value Home buyers are willing to pay $2,600 (on average) more to avoid the increase in the concentration of fecal coliform. Do people actively think about water quality when buying a home or are there correlated variables (such as distance to landfills)

Conclusions/Discussion Assumptions 1. Perfect Information: buyers observe properties and are able to make informed decisions based on the characteristics 2. Market availability: buyers are free to purchase whatever housing characteristics they desire. 3. Marginal Variation: All buyers are not identical! If buyers are willing to pay x price for 2 bedrooms, then they should be willing to pay y price for 5 bedrooms… but this assumption may be too strong! 3.1 Marginal Variation on an individual level: In order to combat the above assumption, we must be able to account for marginal demand on an individual level… is this possible?

Conclusions/Discussion Advantages Ability to estimate values based on actual choices Property markets are efficient reflections of value and reliable Data on property markets is often relatively available Not subject to “survey bias” Large sample sizes – robust The method is flexible, it can be used to determine many non-market valuations.

Conclusions/Discussion Issues The scope is limited to Housing prices – rural areas? Data intensive – Requires a large quantity of accurate information. Limited location comparison – Can results be compared to other areas? Cannot be used to value purely public goods – national defense? The variables are many and interconnected – complex choice bundles Outside influence – how to tax rates, and outside markets affect choice? Hedonic pricing can be complex – requires in-depth statistical knowledge Time consuming – this method requires time and money. People are imperfect consumers – Do they know all the benefits?

Conclusions/Discussion Can you give examples of some linear vs. non linear Hedonic price functions? How can we deal with the “correlation” issue? Is there a sample selection bias in HP analysis? Sold vs. unsold property What is the best method for environmental valuation? If cost is not a factor, how much weight should be given to each method?