On land price formation: Bubble versus option

This paper investigates the theory of land price formation, taking into con sideration the fact that an "option" is implicitly attached to land. Using a theoretical model, it tries to explain the land price bubbles in Japan in the late 1980s as the result of investors' expectations of alternative use s of the land. The model is estimated and validated using data on the Tokyo metropolitan residential area. The modelling exercise also determines the extent to which the option contributes to the formation of land prices. It is shown that the separation of the land price from its fundamental value c an be satisfactorily explained by the option property of land. JEL Classifi cation Numbers: C53, G12, R14.