Hedonic pricing evaluates the benefit of a non-market characteristic (e.g., pollution, fatality risk) on market prices. It is most commonly applied to variations in residential prices reflecting the value of local environmental attributes.
- Value of sound walls: The difference in price between houses adjacent to a freeway with a sound wall and similar houses adjacent to a similar freeway without a sound wall.
- Value of reduced travel time to central city: The difference in price between similar houses located at different travel time distances from the central city.
The basic premise of the hedonic pricing method is that the price of a marketed good is related to its characteristics, or the services it provides. For example, the price of a car reflects the characteristics of that car—transportation, comfort, style, luxury, safety features, fuel economy, etc. The individual characteristics of a car or other good can be valued by looking at how its price people changes when controlling for other characteristics.
Uses of Hedonic Pricing
Hedonic pricing is a convenient method for estimating transportation-related benefits and disbenefits affecting residential property values. These can be negative benefits of transportation facilities such as freeway noise, or positive benefits such as improved access to activities.
Application of the Hedonic Pricing Method Using Residential Prices
The first step is to collect data on residential property sales in the region for a specific time period (usually one year). The required data include:
- selling prices and locations of residential properties
- property characteristics that may affect selling prices, such as lot size, number and size of rooms, and number of bathrooms
- neighborhood characteristics that may affect selling prices, such as property taxes, crime rates, and quality of schools
- accessibility characteristics that may affect prices, such as distances to work and availability of public transportation
- environmental characteristics that may affect prices
Data on housing prices and characteristics are available from municipal offices, multiple listing services, and other sources.
Once the data are collected and compiled, the next step is to statistically estimate a function that relates property values to property characteristics. Regression analysis is typically used to estimate the influence of various property characteristics.
A model for a set of factors determining house prices could be:
P = f (D, S, V, E, H, T)
P = Price
This is called a hedonic price function. The regression typically uses the logarithms of the values for the various factors. A statistical analysis package such as the Regression function in Microsoft Excel or SPSS can be used for the computations of the following type of equation:
ln (P) = ln β0 + β1 ln (D) + β2 ln (S) + β3 ln (V) + β4 ln (E) + β5 ln (H) + β6 ln (T) + e
The β values represent the role that each factor plays in the value of the residence. For example β5 is the value of each unit of proximity to the highway.
Advantages of the Hedonic Pricing Method
- The method's main strength is that it can be used to estimate values based on actual choices.
- Property markets are relatively efficient in responding to information, so they can be good indications of value.
- Property records are typically very reliable.
- Data on property sales and characteristics are readily available through many sources and can be related to other secondary data sources to obtain descriptive variables for the analysis.
- The method is versatile, and can be adapted to consider several possible interactions between market goods and transportation benefits.
Issues and Limitations
- The scope of benefits that can be measured is limited to things that are related to housing prices.
- The method will only capture people's willingness to pay for perceived differences in attributes.
- The method assumes that people have the opportunity to select the combination of features they prefer, given their income. However, the housing market may be distorted by outside influences, like taxes or interest rates.
- The method is relatively complex to implement and interpret, requiring a high degree of statistical expertise.
- The results depend heavily on model specification.
- Large amounts of data must be gathered and manipulated.
Case Study Example of the Hedonic Pricing Method
The study found that the following variables that are relevant for local environmental management had significant effects on property values in Southold:
- Open Space: Properties adjacent to open space had, on average, 12.8% higher per-acre value than similar properties located elsewhere.
- Farmland: Properties located adjacent to farmland had, on average, 13.3% lower per-acre value. Property values increased very slightly with greater distance from farmland.
- Major Roads: Properties located within 20 meters of a major road had, on average, 16.2% lower per-acre value.
- Zoning: Properties located within an area with two- or three-acre zoning had, on average, 16.7% higher per-acre value.
- Wetlands: For every percentage point increase in the portion of a parcel classified as a wetland, the average per-acre value increased by 0.3%.
Based on the results of this study, managers could, for example, calculate the value of preserving a parcel of open space, by calculating the effects on property values adjacent to the parcel. For a hypothetical simple case, the value of preserving a 10 acre parcel of open space, surrounded by 15 "average" properties, was calculated as $410,907.
Boardman, A., D. Greenberg, A. Vining, and D. Weimer. Cost-Benefit Analysis: Concepts and Practice. pp. 339-344.
King, D.M. and M. Mazzotta, Ecosystem Evaluation (website). Available at: http://www.ecosystemvaluation.org/hedonic_pricing.htm.
Crouter, J. P.: 1987, ‘Hedonic estimation applied to a water rights market’, Land Economics63, 259-271.CrossRefGoogle Scholar
European Commission: 2000a, ‘Pricing policies for enhancing the sustainability of water resources’, COM (2000), 477 final.Google Scholar
European Commission: 2000b, ‘Directive 2000/60/EC of the European Parliament and of the Council establishing a framework for community action in the field of water policy’, Official J. European CommunitiesL327, 22/12/2000Google Scholar
Faux, J. and Perry, G. M.: 1999, ‘Estimating irrigation water value using hedonic price analysis: a case study in Malheur County, Oregon’, Land Economics75, 440-452.CrossRefGoogle Scholar
Garrod, G. D. and Willis, K. G.: 1999, Economic Valuation of the Environment, Edward Elgar, Cheltenham, 400 pp.Google Scholar
Gujarati, D. N.: 1995, Basic Econometrics, McGraw-Hill, Singapore, 838 pp.Google Scholar
Johansson, R. C.: 2000, ‘Pricing Irrigation Water: a Literature Review’, Report No. WPS 2449, The World Bank, Washington, D.C.Google Scholar
Latinopoulos, P. and Mallios, Z.: 2001, ‘Economic valuation of irrigation water by the contingent valuation method’, Hydrotechnica11, 3-18 (in Greek).Google Scholar
Madison, D.: 2001, ‘A hedonic analysis of agricultural land prices in England and Wales’, Eur. Rev. Agric. Econ.27, 519-532.CrossRefGoogle Scholar
Mallios, Z. and Latinopoulos, P.: 2001, ‘Willingness to pay for irrigation water: a case study in Chalkidiki, Greece’, in T. D. Lekkas (ed.), Proceedings 7th International Conference on Environ-mental Science and Technology, Ermoupolis, Greece, September 2001, pp. 566-573.Google Scholar
National Research Council: 1997, Valuing Ground Water: Economic Concepts and Approaches, National Academy Press, Washington, D.C., 204 pp.Google Scholar
North, J. H. and Griffin, C. C.: 1993, ‘Water source as a housing characteristic: hedonic property valuation and willingness to pay for water’, Water Resour. Res.29, 1923-1929.CrossRefGoogle Scholar
OECD: 1997, Agricultural Water Pricing in OECD Countries, OECD, Paris.Google Scholar
OECD: 1998, Sustainable Management of Water in Agriculture: Issues and Policies, The Athens Workshop, OECD, Paris.Google Scholar
OECD: 1999, The Price of Water: Trends in OECD Countries, OECD, Paris.Google Scholar
Palmquist, R. B.: 1989, ‘Land as a differentiated factor of production: a hedonic model and its implications for welfare measurement’, Land Econ.65, 23-28.CrossRefGoogle Scholar
Pearce, D.: 1999, ‘Water pricing: conceptual and theoretical issues’, Mimeo, CSERGE, University College London and University of East Anglia.Google Scholar
Roka, F. M. and Palmquist, R. B.: 1997, ‘Examining the use of national databases in a hedonic analysis of regional farmland values’, Am. J. Agric. Econ.79, 1651-1656.Google Scholar
Tiwari, D. N.: 1998, ‘Determining Economic Value of Irrigation Water’, Working Paper GEC 98-05, CSERGE, University College London and University of East Anglia.Google Scholar
Torell, A., Libbin, J. and Miller M.: 1990, ‘The market value of water in the Ogallala aquifer’, Land Econ.66, 163-175.CrossRefGoogle Scholar
Tziakas, V.: 2001, ‘The Valuation of Irrigation Water by a Revealed Preferences Approach’, Post-graduate Diploma Thesis, Department of Civil Engineering, Aristotle University of Thessaloniki, 130 pp. (in Greek).Google Scholar
Xu, F., Mittelhammer, R. C. and Barkley, P. W.: 1993, ‘Measuring the contributions of site character-istics to the value of agricultural land’, Land Econ.69, 356-369.CrossRefGoogle Scholar
Young, R. A.: 1996, ‘Measuring economic benefits for water investment and policies’, World Bank Technical Paper No. 338, The World Bank, Washington, D.C.Google Scholar