On the use of the Financial Option Price Model to Value and Explain Vacant Urban Land

This paper reviews the financial option model of under‐utilizing urban land, with primary attention to the question of whether and how the model might move beyond the academic realm toward practical and quantitative applications. It is argued that the theoretical underpinnings that give the option model such power in the financial securities field do not extend to land applications, making it more important to justify the model empirically. Numerical analysis using a “decision analysis” type model of land option value is used in the paper to help guide and focus such empirical study. It is noted that while the option model focuses primary attention on uncertainty in future building values as the cause of land being held undeveloped, previous deterministic models focused on expected future growth in such values as the main cause for land speculation. As these two causes can have different policy implications, it would be desirable to use empirical analysis to gauge their relative importance. A strategy for empirically testing the option model of land is suggested, and concludes that definitive empirical tests will be difficult to achieve, in part because of the subjective nature of many of the model inputs.