A Real Options Approach to Amenity Valuation the Role of Uncertainty and Risk Aversion

Many empirical studies in the fields of urban and environmental economics rely on the hedonic pricing framework as described by Rosen (1974). The present paper draws attention to two important elements that are not covered by this theory: relocation costs and uncertainty. A theoretical model is developed that highlights key aspects of a local housing market and allows discussing implications for empirical estimates. The model shows that relocation costs are related to uncertainty due to the option value of waiting. Following Fischel (2001), this phenomenon might explain why many facility siting controversies are so difficult to solve. Moreover, the model suggests that the implicit price of environmental quality increases with uncertainty even if agents are risk-neutral. Agents' attitudes toward risk influence this relationship: Under risk-aversion, higher uncertainty leads to a stronger increase in the implicit price