A Rational Expectations Approach to Hedonic Price Regressions with Time-Varying Unobserved Product Attributes: The Price of Pollution

Patrick Bajari, Jane Fruehwirth, Kyoo il Kim () and Christopher Timmins

American Economic Review, 2012, vol. 102, issue 5, 1898-1926

Abstract: We propose a new strategy for a pervasive problem in the hedonics literature: recovering hedonic prices in the presence of time-varying correlated unobservables. Our approach relies on an assumption about home buyer rationality, under which prior sales prices can be used to control for time-varying unobservable attributes of the house or neighborhood. Using housing transactions data from California's Bay Area between 1990 and 2006, we apply our estimator to recover marginal willingness to pay for reductions in three of the EPA's "criteria" air pollutants. Our findings suggest that ignoring bias from time-varying correlated unobservables considerably understates the benefits of a pollution reduction policy. (JEL D12, D84, Q53, Q58, R21)

Date: 2012
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