Residential property value and locational externalities

Abstract

It is well‐known from the literature that locational externalities influence the price formation of residential property. This effect is usually studied empirically with the hedonic price models, by including various neighbourhood and proximity variables in the model. These regression based techniques have, however, been criticised for a number of reasons. The arguments pertain partly to technical issues such as model flexibility, functional discontinuity and nonlinearity, and data quality, and partly to more fundamental problems regarding the nature of the value formation process. The criticism has attracted experiments with new modelling approaches, each of which adds something substantial to the hedonic approach. The study comprises two parts: it first highlights the rationale behind each broad approach composed of specific modelling techniques currently available, and then demonstrates an improvement of the demand side analysis by applying the analytic hierarchy process. This method enables quantification of qualitative expert judgements, and may lead to conclusions that go beyond the purely economic value framework.