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Quasi Experiments, Hedonic Models, and Estimating Trade-offs for Local Amenities

Authors

H. Allen Klaiber and V. Kerry Smith.

Journal

Land Economics, Volume 89, Number 3, August 2013

Abstract

This paper evaluates whether the property value capitalization effects measured with quasi-experimental methods offer reliable estimates of willingness to pay for changes in amenities. We propose the use of a market simulation as a robustness check. Two applications establish the method’s relevance. The first examines the conversion of land cover from desert to wet landscape. The second examines cleanup of hazardous waste sites. We find that even when quasi-experimental methods have access to ideal instruments, their performance in measuring general equilibrium willingness to pay cannot be assumed ideal. It needs to be evaluated considering the specific features of each application.

Introduction

There is a fundamental distinction between estimating the effect of a policy that influences the value of a parcel on that land’s price and estimating what an individual would be willing to pay to obtain the policy. This issue is important to nearly all of the reduced form quasi-experimental (QE) and hedonic property value analyses conducted over the past decade. This distinction arises because the source of identifying information used to avoid biases in hedonic estimates that can arise from omitted variables and sorting behavior is not neutral to the economic interpretation of what is measured.1 Two approaches have been used to evaluate the empirical significance of this logical distinction in recovering estimates of economic trade-offs associated with a change in a nonmarket service. The first uses analytical models to describe the properties of these trade-off estimates, using the evaluation logic often associated with quasi experiments.2 The second approach uses simulation methods to evaluate the quantitative importance of distinguishing specific types of changes in site-specific amenities and [End Page 413] compares the evaluation logic to conventional cross-sectional hedonic methods.

The theoretical analysis by Kuminoff and Pope (2012) is an example of the first strategy. They adapt the Tinbergen-and-Jan-1959Tinbergen (1959)-Epple (1987) description of the features of a hedonic price function to describe a hedonic equilibrium. With this model they demonstrate that for an infinitesimal, exogenous change in a spatial attribute, conveyed with a house, the prechange and postchange marginal willingness to pay (MWTP) measures will be equal and correspond to the incremental price capitalization. However, in other situations the price differential associated with capitalization may not correspond to either the prechange or the postchange MWTP. In evaluating policies that are inherently nonmarginal, the close relationship between capitalization and willingness to pay (WTP) may not hold. In the current paper, we use simulation methods originating in the logic developed by Cropper, Deck, and McConnell (1988) and Kuminoff, Parameter, and Pope (2010) to provide a strategy for developing an understanding of this relationship as it arises in each specific type of application. An economic model, calibrated to a specific market, is used to simulate different hedonic equilibria and then to evaluate the performance of conventional cross-sectional hedonic models and methods based on the logic of program evaluation for estimating specific trade-offs people would make in response to changes in spatially varying amenities.

Our analysis complements the existing hedonic simulation papers and extends them to demonstrate how a market simulation can serve as a robustness check on the maintained assumptions of the evaluation logic when it is used to develop measures in property value applications of the trade-offs a person would make to secure more of a desirable amenity. For small changes, analysts have interpreted these measures as point estimates of the MWTP. For large, discrete changes associated with some applications of the evaluation framework, the appropriate interpretation of these measures is a topic of debate. Our analysis provides additional guidance on the interpretation of these measures. We focus on situations where the measure of interest is the general equilibrium willingness to pay (GE WTP) for changes in amenities, which is often the goal of policy analysis. We present two examples to illustrate the importance of a simulation check. Our findings in these examples imply that quasi experiments that are routinely a part of the evaluation logic can have large errors when their estimates of price capitalization are treated as estimates of WTP. We also find that the use of instruments with cross-sectional hedonic modeling can improve the quality of the estimates for the WTP for discrete changes in amenities. This is true even when the changes are large enough to induce re-sorting and result in a new hedonic price function. Finally, we find that the context for each application matters, so that general conclusions about robust strategies for estimating GE WTP do not follow; and therefore, it would be prudent to consider the use of similar simulations as a complement to empirical research on a case-by-case basis.

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