What Can We Learn From Hedonic Models Where Markets Are Dominated By Foreclosures?

Hedonic property value models have been frequently used to value environmental amenities (or dis-amenities) since markets for these goods (bads) do not usually exist. Typically, researchers cite Rosen’s (1974) seminal work that allows one to interpret functions of the hedonic regression coefficients as the marginal willingness to pay (MWTP) for the environmental good. This allows the results from the hedonic models to be used to evaluate the net benefits from environmental policies and actions such as cleaning up Superfund sites and improving air and water quality. There are a number of assumptions needed for the Rosen result to hold. However, under extreme circumstances in the housing market, these assumptions are unlikely to be realistic. Recent years have witnessed such extreme circumstances, such as wild swings in housing prices, high levels of mortgage default, and most significantly, high levels of foreclosure. In this paper, we address the following question "How can we interpret the coefficient estimates for environmental goods in hedonic property value models where markets are dominated by foreclosures?" The key point is that the Rosen framework for developing the hedonic model and interpreting the coefficients in this model as MWTP relies on an equilibrium assumption that is questionable in today’s housing market that is dominated by foreclosures. In order to evaluate the impact of foreclosures on the housing market in general and more specifically on the interpretation of the coefficients for environmental variables in the hedonic model, we develop a disequilibrium model of the housing market that explicitly accounts for foreclosures through their impact on vacancies. We also raise issues having to do with composition bias in hot and cold markets and how this affects the coefficients in the hedonic model.