A Research on the Mechanisa of Land Price Forpation and the Option Propenty of Land

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According to the standard asset pricing theory, land price is determined to be equal to the discounted sum of future rent revenues from land. However, the recent land price movements in Japan seem to be disobeying this economic rule. In this study, we attempt to construct a new model of land price formation under uncertainty to rationally explain the recent land price movements in Japan. In particular, we explicitly consider multiple land uses and the conversion of land among alternative land uses in the model and highlight an option property of land which has been ignored in the previous researches. The main results obtained in this study can be summarized as follows. First, even though there exist no bubbles, land can be rationally priced far beyond its fundamental value. Second, increased uncertainty in the stochastic processes of the fundamental values of land may increase land prices rather than decrease them.Third, the option property of land can naturally give rise to the excess volatility and the downward rigidity of land prices. In addition, we perform an empirical analysis using the data of the Tokyo metropolitan residential area from 1971 through 1990. This empirical analysis uncovers that the option value of the land in this area is an important factor which can solely explain almost half of the difference between the actual land price and its fundamental value.