Journal of Real Estate Finance and Economics, 3:11%140 (1990) 9 1990 Kluwer Academic Publishers The Value of Risk in Real Estate Markets

In this article we test he urban asset pricing model of Capozza nd Sick (1988) and focus on the empirical dimen-sions of the effects of risk on urban land prices. The effects of systematic and unsystematic risk are distinguished in the model which incorporates the value of the option to convert land to urban uses into the pricing of urban real estate. We find the value of systematic r sk in our Canadian urban areas to he negative and highly statistically significant. We find that approximately 2.5 percent of the value of houses in our sample arises from systematic risk. In our sample, unsystematic r sk is a larger proportion of total risk than systematic risk. Therefore, most of the effect of total risk may be ascribed to unsystematic risk. The effect of total risk on land prices is illustrated through the irreversibility premia estimates. These premia vary greatly in size and statistical significance. Thus, the effect of unsystematic risk is highly city specific. In the two regions where the irreversibility premia re statistically significant, it accounts for 22 percent and 53 percent of the average housing price; thus, unsystematic risk can be a very important determinant ofhousing prices. These results highlight he importance of risk in determining urban land prices. The value of the option to convert land to urban uses imparts considerable value to developed land and must be considered when evaluating interurban area price differences