Abstract
In this article we test the urban asset pricing model of Capozza and Sick (1988) and focus on the empirical dimensions of the effects of risk on urban land prices. The effects of systematic and unsystematic risk are distinguished in the model which incorporates the value of the option to convert land to urban uses into the pricing of urban real estate. We find the value of systematic risk in our Canadian urban areas to be negative and highly statistically significant. We find that approximately 2.5 percent of the value of houses in our sample arises from systematic risk. In our sample, unsystematic risk is a larger proportion of total risk than systematic risk. Therefore, most of the effect of total risk may be ascribed to unsystematic risk. The effect of total risk on land prices is illustrated through the irreversibility premia estimates. These premia vary greatly in size and statistical significance. Thus, the effect of unsystematic risk is highly city specific. In the two regions where the irreversibility premia are statistically significant, it accounts for 22 percent and 53 percent of the average housing price; thus, unsystematic risk can be a very important determinant of housing prices.
These results highlight the importance of risk in determining urban land prices. The value of the option to convert land to urban uses imparts considerable value to developed land and must be considered when evaluating interurban area price differences.
Similar content being viewed by others
References
Capozza, D.R., and Helsley, R. “The Stochastic City.” Journal of Urban Economics (forthcoming, 1990).
Capozza, D.R., and Li, Y. “A Generalized Model of Land Conversion Under Uncertainty.” Mimeo, University of Michigan, 1989.
Capozza, D.R., and Schwarm, G. “The Asset Approach to Pricing Urban Land: Some Empirical Results.” AREUEA Journal 17, 2 (1989), 161–175.
Capozza, D.R., and Sick, G. “Risk and Return in the Land Market.” Journal of Finance, (forthcoming) 1988.
Case, K. and Schiller, B. “The Efficiency of the Market for Single-Family Homes.” American Economic Review 79 (1989), 125–137.
Copeland, T., and Weston, F. Financial Theory and Corporate Policy. Addison-Wesley, 1989.
Kmenta, J. Elements of Econometrics. New York: Macmillan, 1971.
Maddala, G.S. Limited-dependent and Qualitative Variables in Econometrics. New York: Cambridge University Press, 1983.
Mills, D. “Growth, Speculation, and Sprawl in a Monocentric City.” Journal of Urban Economics 10 (1981), 201–226.
Schwann, G.M.“Optimal Production Scheduling in Construction.” Mimeo, 1989.
Author information
Authors and Affiliations
Rights and permissions
About this article
Cite this article
Capozza, D.R., Schwann, G.M. The value of risk in real estate markets. J Real Estate Finan Econ 3, 117–140 (1990). https://doi.org/10.1007/BF00216587
Issue Date:
DOI: https://doi.org/10.1007/BF00216587