Hedonic Evaluation Approach
The hedonic approach is based on the assumption that goods can be considered aggregates of different attributes, some of which, as they cannot be sold separately, do not have an individual price. On real estate markets for example, it is not possible to purchase separately the room, the preferred location, the panoramic qualities, quality of air or of surrounding landscape.
The hedonic approach to evaluation attempts to estimate implicit prices of single characteristics of a good on the basis of market values of the whole goods. The use of this approach is of particular interest in the field of environmental valuation, as it can be assumed that the values attributed to natural resources are attributes of commodities which are sold on the market. Obvioulsy, more closely are market goods related to the use of a natural resource, more suitable is this approach for the evaluation of the natural resource. Real estate properties are very interesting for this approach as their values are strongly influenced by locational characteristics.
The approach assumes that the economic value of each attribute influences the total value of the commodity and thus can be revealed as a difference in prices of real estate properties, assuming all other characteristics to be constant. The approach is based on the identification of the part of value which regards the characteristic * to be evaluated, and in case of variations of the characteristic, on the possibility of estimating its demand function. The theory at the basis of hedonic methods has been formulated by Rosen (1974) and successively improved with regards to the valuation of environmental goods by Freeman (1979.Rosen’s model simulates a competitive market and foresees the simultaneous estimation of demand and supply function. In the particular case of real estate markets, with a very rigid supply, the model can be simplified and traced back to the neoclassic scheme of the theory of consumer’s demand (Diamond and Smith 1985). The correct application of the hedonic approach requires in any case that the following hypothesis have been positively verified:
- the market must offer a continuous range of choices, that means, all combinations between private good and environmental conditions;
- purchasers must be able to behave according to the principle of decreasing marginal utility with respect to the environmental characteristics;
- purchasers must have the same opportunity of access to the market. In other words, they must have the same cost of information, transaction and transfer, the same income available and the same mobility;
- a perfect transparency of prices and characteristics must be given;
- prices must adapt immediately to changes in the demand for environmental goods.
These hypothesis are of course restrictive, as they describe a market which is perfectly transparent on the side of the offer, and, is homogeneous and perfectly competitive on the demand side.
On an operative level the approach proceeds in two phases:
- estimate the value function of the private good;
- estimate of the demand function of the environmental characteristics of the surplus.
The estimation of the function of the prices of private goods is generally obtained applying statistical methods of linear (or linearized) multiple regression: [math][/math]
In this way each single characteristic of the good is associated with a parameter ßi which represents, if the above conditions are satisfied, according to the specification of the variable, the implicit price. The hedonic approach shows, besides its doubtless advantages, some limits which add to the general one of respecting the hypothesis on the characteristics of real estate markets:
- it can be applied only in presence of a good number of market exchanges, as the model representing the market requires a certain number of good quality data;
- the market must be sufficiently transparent;
- the valuation might be biased if there are expectations with regards to changes in environmental qualities;
- It is not possible to estimate the total economic value of the environmental good, but only the value connected to present and, with some caution, future uses.
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