A Hedonic Price Analysis of Farmland Option Premiums Under Urban Influences Tamer Isgin 1 and D. Lynn Forster 2 1 Assistant Professor, Department of Agricultural Economics, University of Harran, Ziraat Fakultesi Tarim Ekonomisi Bolumu, Eyyubiye Kampusu Sanlıurfa, Turkey (phone: 01190-414-247-2222; fax: 01190-414-247-4480; e-mail: tisgin@yahoo.com). 2 Professor, Department of Agricultural, Environmental, and Development Economics, Ohio State University, 2120 Fyffe Road, Columbus, OH 43201-1067 (phone: 614-292-6340; e-mail: Forster.4@osu.edu). An emerging theory, real option pricing, suggests that an important component of urban fringe farmland values may be the option value arising from nearby urban development. This new option pricing theory, as opposed to its standard conventional counterpart in finance, incorporates both the uncertainty about the future net benefits of a land conversion decision and the irreversibility of this action taken. We demonstrate that parsimonious empirical hedonic models of the errors-in-variables type, when corrected for heteroskedasticity, can provide adequate representations of farmland option premiums. Data for a random sample of cash rented Ohio farmland parcels are used, and the impacts of urban development on farmland option premiums are estimated. Results provide evidence that (a) both land-use conversion probability and urban influences have been important factors affecting the option value of the state’s farmland, and (b) these option premiums associated with irreversible and uncertain land development are capitalized into farmland values. Une nouvelle th´ eorie, l’´ evaluation des options r´ eelles, semble indiquer qu’un ´ el´ ement important de la valeur des terres agricoles p´ eriurbaines pourrait ˆ etre la valeur d’option d´ ecoulant du d´ eveloppement urbain avoisinant. Cette nouvelle th´ eorie, contrairement aux options financi` eres, inclut ` a la fois l’incertitude quant aux b´ en´ efices nets futurs li´ es ` a la d´ ecision de convertir une terre et l’irr´ eversibilit´ e de cette d´ ecision. Nous avons d´ emontr´ e que les mod` eles empiriques parcimonieux et h´ edoniques du type erreurs sur les variables peuvent, une fois l’h´ et´ erosc´ edasticit´ e corrig´ ee, donner des pr´ esentations ad´ equates des prix de l’option des terres agricoles. Nous avons utilis´ e les donn´ ees d’un ´ echantillon al´ eatoire de parcelles de terres agricoles lou´ ees au comptant en Ohio et nous avons estim´ e l’impact du d´ eveloppement urbain sur le prix de l’option des terres agricoles. Les r´ esultats ont montr´ e: a) que la probabilit´ e de conversion de l’utilisation des terres et les influences urbaines sont des facteurs importants qui influent sur la valeur de l’option des terres agricoles de l’ ´ Etat; b) que ces prix de l’option associ´ es ` a un am´ enagement urbain irr´ eversible et incertain sont int´ egr´ es dans la valeur des terres agricoles. INTRODUCTION The well-known functions of farmland, such as producing incomes for owners and tenants, generating amenity values for public, and providing governments with a taxation medium, have led to an increasing research interest in land valuation as evidenced by the fact that no other factor of production has been the subject of so many inquiries about its valuation (Xu et al 1993). The commonly accepted theory of land valuation is that the value of Canadian Journal of Agricultural Economics 54 (2006) 327–340 327