Journal of Urban Economics 60 (2006) 33–49

www.elsevier.com/locate/jue

Estimation of the bid rent function with the usage

decision model ✩
Sachio Muto ∗
Land Policy Division, Land and Water Bureau, Ministry of Land, Infrastructure and Transport, 2-1-2 Kasumigaseki,
Chiyoda-Ku, Tokyo 100-8940, Japan
Received 16 August 2004; revised 3 October 2005
Available online 2 May 2006

Abstract
This paper examines whether the bid rent function model is a valid description of a mechanism of the
urban land market. We estimate the function that decides land usage and price using the full information
maximum likelihood (FIML). It finds that land usage on average follows the rule that is consistent with the
bid rent function model: whichever usage outbids the others occupies the land. However, the evidence also
suggests that there is a systematic departure from the model. Namely, the distance from the second city
center may directly affect land usage even though it is not reflected in land prices.
© 2006 Elsevier Inc. All rights reserved.

Keywords: Bid rent function; Selection bias; Full information maximum likelihood

1. Introduction

This paper investigates how the sectoral valuation process for land price affects land usage
in a single city. Numerous applications of the standard urban economic model (the monocentric
city model) have developed during the last four decades. Typically, the standard urban economic
model for a single city includes the notion of “bid rent function,” which clearly formulates the
mechanism of land price and usage: a parcel of land is occupied by that usage with the highest
valuation. In other words, whichever usage outbids the others occupies the land.

✩
The views expressed in this paper are totally the author’s and do not represent those of the Ministry.
* Fax: +81 3 5253 8290.
E-mail address: mutou-s2af@mlit.go.jp.

0094-1190/$ – see front matter © 2006 Elsevier Inc. All rights reserved.
doi:10.1016/j.jue.2005.10.005
34 S. Muto / Journal of Urban Economics 60 (2006) 33–49

The purpose of this study is to examine empirically whether land is used according to this
rule of the bid rent function model, and to seek the determinants that affect land price and usage.
Although there are abundant empirical analyses on the hedonic pricing of home sale values, there
are, as far as we know, no studies that empirically investigate how the differences in valuations of
land (the bid rent function) by different sectors affect the actual usage of land in a single city. This
paper investigates a situation where residential and commercial usages are bidding for the same
parcels of land in a city. We set up a model with three functions: one usage decision function and
two land value functions. The location choice function includes information on the land value
functions and determines land usage. If the coefficients in these three functions are identified, we
can infer whether the location choice is affected by the difference in the price valuations.
However, there is a compelling difficulty involved with our analysis: namely, the valuation
of land other than the current usage is unobservable (latent) and we tend to observe a particular
land usage that would outbid other usages. This difficulty is depicted in Ellickson [3] and Lerman
and Kern [10], and they developed the Full Information Maximum Likelihood (FIML) estima-
tion model for estimating the land price function under the land-bidding process. In the 1990s,
McMillen dealt with this issue in his and his colleagues’ paper, and he developed an estimation
model for land prices with various land market settings. For example, McMillen et al. [12] deals
with the effect of land development and the expansion of urban land use on land prices. Using
the two-stage estimation technique with historical data, they found that the city expands by con-
verting low-quality agricultural land into high-quality urban land. Later, McMillen [11] points
out that the so-called selectivity correction approach, such as in Dubin and McFadden [2] and
Lee [9], can be used as an approximation for estimating the bid rent function.1
Although technically similar to these works on stochastic bid rent function approaches, where
they try to alleviate the possible selection biases on urban land prices, the purpose of this paper
is to capture the relationship between land prices and usage decisions. More specifically, the
approach taken in this paper is to compare the price of the actual land usage with the latent
value of the same land for an alternative usage. While McMillen’s method [11] can be used to
estimate land prices alone, it cannot be used to compare the usage decision equations and land
price equations to test the validity of the bid rent function theory.
We used a modified version of Lerman and Kern’s full information maximum likelihood
(FIML) estimator [10]. That estimator, in its original form, is too restrictive in that it is based on
the assumption that land is always occupied by the particular usage that outbids others. There-
fore, we modify Lerman and Kern’s FIML [10] by incorporating variables other than the price
that could affect land usage. We estimate the determinants and structure of the actual valuation
of land price data and other attributes.2
This paper investigates the actual mechanism of determining the usage and price of land,
using data from Tokyo, Japan. The results show that various attributes, such as the distance from

1 One of the other important topics dealt with in McMillen’s work is the effect of zoning on land prices. For example,
McMillen and McDonald [13,14] employ the simultaneous equation of land price equations and zoning decision equa-
tions. McMillen and McDonald [13] find that there are selectivity biases for single-family residential land created by
the determinants of zoning and affected land prices in Chicago. However, McMillen and McDonald [14] concluded that
the zoning in 1920s Chicago could not bring about the general increase in land prices. In the context of our model, it
is necessary for us to consider three types of equations, which describe the mechanism of land prices, zoning decisions,
and usage decisions.
2 Horowitz [8] shows empirically that the housing bidding processes cannot be described by the standard random
bidding model in Ellickson [3] and Lerman and Kern [10], because sellers do not know precisely the future bid price of
land. Horowitz’s model [8] is based on a single regime bidding process and cannot be used for the analysis in this paper.
 S. Muto / Journal of Urban Economics 60 (2006) 33–49 35

the center of the city, train or subway stations, major roads, schools, parks, and the coast, may
affect the valuation of land for both residential and commercial usage. Further, the effect of
these attributes on land usage is mainly through the difference in the valuations of land between
residential and commercial usage, rather than directly affecting the specific usage of land. More
specifically, most of the estimated coefficients that could capture the departure of land usage from
the difference in valuations are insignificant. For example, the distance to major roads negatively
affects both commercial and residential land prices, and the effect is larger for commercial land
than for residential. However, the coefficient that would capture the direct effect of the distance
to the second center of the city is significant at a 5% significance level. The estimates suggest
that a parcel of land close to the second center is more likely to be occupied by residential usage
than what is implied by the difference in prices. In summary, the bid rent function model is a
largely valid model for describing the mechanism of the usage and the price of land in a single
city, although there can be a systematic departure from the model.
This paper is structured as follows. The next section, Section 2, overviews the estimators that
can be used for estimating the bid rent function, extending the Lerman and Kern’s FIML [10].
Section 3 investigates the land price data and identifies the center of the city by capturing the
relationship of land price with respect to longitude and latitude. The mechanism for determining
land usage and price is examined in Section 4.

2. Estimation models

2.1. Stochastic bid rent function

As in Alonso’s work [1], the bid rent function model is established under the non-stochastic
assumption of the price and usage of land. However, to apply the urban economic model in
reality, we need to take into account the stochastic aspects of land rent or location choice be-
havior. The first work on the stochastic bid rent function was developed by Ellickson [3]. He
formalized the estimation method of the stochastic bid rent function using the revealed probabil-
ity of the heterogeneous households’ location choice. For the sake of notational simplicity and
consistency throughout this proposal, we recast his multiple regimes land-bidding model among
heterogeneous households into a double regimes (residential and commercial) linear model.
Assume that the residential sector and the commercial sector are bidding on a parcel of land in
a city. Let Vt be the stochastic valuation of the land price for regime t, which is either residential
(denoted as r) or commercial (denoted as c). Then, the Vt of a parcel of land i can be described
such that

Vti = Zi βt + εti (t ∈ r, c), (1)

where Zi denotes the attributes vector for land i and is assumed to linearly determine the sys-
tematic component of Vt . βt is the coefficient vector of Zi , and it is heterogeneous between
residential and commercial usage. εti is the random component of land value and, in Ellickson’s
model [3], it follows the i.i.d. extreme value distribution.
Then, following the assumption of the bid rent function model, the probability that the
regime r occupies land i(pri ) is given by the probability that the residential usage evaluates
land i equal to or higher than the commercial usage:

pri = prob{Zi βr + εri  Zi βc + εci }. (2)

36 S. Muto / Journal of Urban Economics 60 (2006) 33–49

Equation (2) is based on the assumption that there is no market friction. That is, the equation
implies that the land is “always” occupied by the usage r if it outbids the other usage c.3
Although Ellickson [3] did not use actual land price data, his formulation shows that the
estimation of the bid rent function is not trivial. That is, the observed land price data contains
self-selectivity bias, since the realized land price is based on the valuation of the usage that
outbids the others. One approach to estimate the bid rent function is to use the following FIML
developed by Lerman and Kern [10]. Denoting the observed land rent at i as Vi∗ , and its random
component as εi∗ , they obtain
Vi∗ = Zi βt∗i + εi∗ , (3)
where Vi∗ = Vri , βt∗i
= βr and εi∗
= εri if Vri  Vci , and = Vi∗
= βc and Vci , βt∗i
= εci if εi∗
Vci > Vri , and εti ∼ i.i.d. extreme value distribution.4

Lerman and Kern [10] argue that the parameter vector β can be estimated using the probability
density of the following event:
{Vi∗ = Zi βt + εti and Zi βt + εti  Zi βt  + εt  i } (t = t  and t, t  ∈ r, c). (4)
Assuming that εti is independent and identically extreme value distributed, the joint distribu-
tion of V ∗ and t is simply the product of the probability density of V ∗ given t and the probability
that type t outbids the others (t  ). Thus, we obtain the joint distribution of V ∗ and t:
     
fi t, Vi∗ = fε Vi∗ − Zi βt Fε Vi∗ − Zi βt  (t = t  and t, t  ∈ r, c), (5)
where fε and Fε denote the extreme value density and the cumulative distribution function,
respectively. Gross [5] estimated the bid rent function in Chicago using this approach.
While Lerman and Kern [10] assume the homoskedastic disturbance for Eq. (5), it can be
generalized so that we allow the disturbance εti to be different between the residential and
commercial land price equations. Moreover, it may be possible that the usage decision can be
dependent on factors other than price. In this generalized case, Eq. (5) can be expressed as fol-
lows:
     
fi t, Vti∗ = fε Vi∗ − Zi βt Fε Vi∗ + Xi γ − Zi βt 
  
= ωt · exp −ωt Vti∗ − Zi βt
      
× exp − exp −ωt Vti∗ − Zi βt − exp −ωt  Vti∗ + Xi γ − Zi βt  ,
     
fi t  , Vt∗ i = fε Vi∗ − Zi βt Fε Vi∗ − Xi γ − Zi βt 
  
= ωt  · exp −ωt  Vt∗ i − Zi βt 
     
× exp − exp −ωt  (Vt∗ i − Zi βt  ) − exp −ωt Vt∗ i − Xi γ − Zi βt , (6)
where t = t  and t, t  ∈ r, c, Xi is the determinants vector of the location choice other than the
difference in land values, and γ is the coefficient vector for Xi . In this paper, we focus specifically
on the case wherein vector Xi is the same as vector Zi , although we can exclude some variables
in Xi if we have a certain variable that affects land prices but does not affect usage. The inclusion

3 Using data from the San Francisco Bay area, Ellickson [3] implicitly estimates the stochastic bid rent function by the
revealed probability of residing in some area by multiple agents.
4 The subscript i for β ∗ is necessary in this expression, because the parameter β depends on the observed usage at
ti
property i. This subscript i for parameter β will be eliminated for the other equations in this paper, where we place
conditions on the usage at property i.
 S. Muto / Journal of Urban Economics 60 (2006) 33–49 37

of Xi makes it possible for us to judge whether there is a direct effect of explanatory variables
on land usage that is not reflected in land prices. There are also two different scale parameters
ωt for fε (Vi∗ − Zi βt ) and ωt  for Fε (Vi∗ − Zi βt  ), where both are the same in Lerman and Kern
[10], in order to reflect the possibility of a different standard error for residential and commercial
land price equations.
Further, for the purpose of checking the robustness of the estimates, we use the distribution
of the error terms εti that follows the normal distribution. Denoting the standard normal density
function as φ(·) and the standard normal cumulative distribution function as Φ(·), Eq. (6) can be
expressed as
       
fi t, Vi∗ = φε Vi∗ − Zi βt /σt · Φε Vi∗ + Xi γ − Zi βt  /σt  ,
        (7)
fi t  , Vi∗ = φε Vi∗ − Zi βt  /σt  · Φε Vi∗ − Xi γ − Zi βt /σt ,
where σt and σt  denote the standard error of the disturbance of land price equations for usage t
and t  , respectively.
Throughout this paper, we refer to the model described in Eq. (6) as the “FIML-Logit” and the
model in Eq. (7) as the “FIML-Probit.” In either case, we maximize the log-likelihood function
derived from Eqs. (6) and (7).

2.2. Selectivity correction approach

McMillen [11] points out that the so-called selectivity correction approach, such as in Du-
bin and McFadden [2] and Lee [9], can be used as an approximation for estimating the bid rent
function. Those approaches have an advantage over Lerman and Kern’s approach [10] since they
do not have to assume the independence between error terms of land value functions. Moreover,
Lerman and Kern’s approach [10] cannot incorporate another error term into the location choice
function, which can allow for a situation where the difference in valuations does not necessar-
ily determine the usage of a parcel of land.5 In this paper, we use Heckman’s model [7] as a
representative model regarding the consistency with the normality assumptions in our model. In
the context of the land rent bidding process between two regimes, we can describe the bid rent
function model as follows.
First, using Heckman’s model [7] in the context of the bid rent function, we can set up the
location choice function described as
Di = Zi βd + εdi , (8)
where Di denotes the latent variable of location choice behavior, and the usage of a parcel of
land i is residential if Di  0 and commercial if Di < 0. βd is the coefficient vector for Zi , and
the error term εdi is assumed to be normally distributed. The coefficient vector βd is equal to the
difference in valuation (βr − βc ) if the bid rent function model holds exactly.
The decision process for land usage in Lerman and Kern’s FIML [10] can also be expressed
as Eq. (8). However, the distribution of εdi is fully determined by εri − εci in Lerman and Kern’s

5 McMillen [11] claims that one of the advantages of the selectivity correction approach over Lerman and Kern’s
approach [10] is that it can incorporate other explanatory variables other than land price, such as zoning, in the location
choice function. However, modifying slightly Lerman and Kern’s likelihood function [10], we can actually incorporate
the additional explanatory variables. That is, we can include additional explanatory variables only for the cumulative
extreme value distribution function of Eq. (5), and derive the likelihood function for the estimation.
38 S. Muto / Journal of Urban Economics 60 (2006) 33–49

FIML [10], where there is no random component in deciding land usage except for the distur-
bances in land price equations. Heckman’s estimator [7] is consistent regardless of the degree of
correlation between εdi and εri − εci in Eq. (8).
Denoting the observed location choice as Di∗ , we have

1 (residential) if Di  0,
Di∗ = (9)
0 (commercial) if Di < 0.

Since we do not identify the scale of Eq. (9), the binary probit estimation is actually performed
based on the rescaled parameter
   
Pri = Prob(D = 1) = Φ Z · (βd /σd ) and Pci = Prob(D = 0) = 1 − Φ Z(βd /σd ) , (10)

where Pri and Pci denote the probability that a parcel of land i is used for residential purposes
and commercial purposes, respectively.
Next, from the observed land rent Vi∗ , we sort out the observed residential land rent (Vri∗ )
and the observed commercial land rent (Vci∗ ). Then, we arrange two equations, which we call the
“land value function,” such that

Vti∗ = Zi βt + δt λti + εti∗ (t ∈ r, c), (11)

where the disturbances for the observed values εti∗ are normally distributed (not i.i.d.). δt is the
estimated coefficient of λti , which is the so-called inverse Mill’s ratio defined as

ti ))
φ(Φ −1 (P
λti = (t ∈ r, c), (12)
ti
P

where P ti is the predicted probability calculated from the estimates of the probit model (10).
φ(·) and Φ −1 (·) denote the standard normal density and the inverse of the cumulative normal
distribution, respectively. Heckman [7] showed that the OLS estimates of Eq. (11) using the
inverse Mill’s ratio (12) are consistent. More specifically, we first estimate Eq. (10) by the probit
model and use the predicted value P ti to construct the inverse Mill’s ratio (λi ) and estimate
Eq. (11) by OLS.
Since we cannot identify the scale of βd and we only retrieve βd /σd by the probit model, it is
impossible for us to use the estimates in Eqs. (10) and (11) in order to examine the relationship
between these equations so as to test the validity of the bid rent function model.6 We should also
note that this sequential estimator is known to be inefficient.7 However, as shown in McMillen
[11], the estimator is still consistent even if the error terms εri and εci are correlated. The es-
timators can be used for the reference values for the estimates βt of the land value functions
in Eq. (7).

6 The estimates of δ contain information about the scale in Eqs. (11). However, we still cannot retrieve the correlation
t
and the variance of the disturbances of the equations separately.
7 See, for example, Hartman [6]. Muto [16] has implemented the Monte Carlo analysis and found that the performance
of Heckman’s estimator measured in terms of the root mean squared errors is often inferior to that of the FIML under the
same sample size of our analysis.
 S. Muto / Journal of Urban Economics 60 (2006) 33–49 39

3. Data

3.1. Description of land price data

We use as our data the publicly announced land prices in Tokyo, Japan, which are called
“Chika Koji.” A valuation of land price is announced every year for each fixed data point in the
urban planning area. The valuation is made by the appointees of the Land Evaluation Committee,
using the data of similar transactions and rental prices around the fixed data points.8 The price is
evaluated so as to reflect the price of vacant land, and the evaluated price reflects what an actual
transaction of the land would involve.
Including land price data, all the data used in this paper are culled from the Land Numeric
Information Service, which is maintained by the Japanese Ministry of Land, Infrastructure and
Transport. For example, the price data are available with the data points’ longitude, latitude,
and the distance from the closest train or subway station. The data also contains the standard
usage of the land, which includes residential, office, shopping, factory, and so on. In this paper,
for simplicity purposes, we restrict ourselves to two kinds of usage—namely, residential and
commercial (shopping and office). The data point used is designated either as residential only or
commercial only, although there are some data points denoting a location where the land is used
for more than one usage. Any such data point is discarded from the sample for the estimation.9

3.2. Variables of the basic model

Using the longitude and latitude data, we can plot the data point two-dimensionally by the
usage of land (Fig. 1). To capture the shape of the land rent gradient without assuming specific
functional form, we perform non-parametric regression of the logarithm of land price with re-
spect to longitude and latitude (Fig. 2).10 We identify the center of the city as the maximum
point of the regression surface. The variable DCBD is measured by the distance from this center
calculated using the longitude and latitude reported in the database. The variable DST is the dis-
tance from the nearest train or subway station, which is directly obtained from the database. The
descriptive statistics of the log of land price, DCBD, and DST are provided in Table 1.

3.3. Other attributes

Since land price and land usage can be affected by factors other than the distance from the city
center and a subway or train station, we need to investigate the effect on prices of other possible
variables (Table 2).
We assume that other attributes such as the accessibility to roads, schools, the coast, and
regional parks may have an effect on the price and usage of residential and commercial land.
Using the data culled from the “geographic database,” we calculated the shortest distance to
those facilities from each data point of land price using the algorithms.11

8 The procedure of announcement and evaluation is legally defined by the Ministry of Land, Infrastructure and Trans-
port.
9 The number of data with such dual usage is 341, out of the original 1665 samples.
10 The estimation model (bivariate nonparametric regression) is described in Appendix A. The kernel density used in
this bivariate nonparametric regression is the Biweight kernel. The bandwidth used in the regression is 0.1 (=1 km). The
estimated surface of Fig. 2 is fairly robust in terms of the choice of bandwidth or kernel density functions.
11 The details of the algorithms are provided in Appendix B.
40 S. Muto / Journal of Urban Economics 60 (2006) 33–49

Fig. 1. Data points of land price by usage (Tokyo’s 23 wards, 2000).

Fig. 2. Land rent gradient (Tokyo’s 23 wards, 2000).

 S. Muto / Journal of Urban Economics 60 (2006) 33–49 41

Table 1
Descriptive statistics for basic variablesa
Overall Residential Commercial
Mean Median Std. Dev. Mean Median Std. Dev. Mean Median Std. Dev.
log of 13.2275 13.0498 0.6969 12.9840 12.9692 0.3193 14.1034 14.0466 0.9419
(Price (yen/m2 ))
DCBD (10 km) 0.9625 1.0174 0.4025 1.0586 1.0943 0.3501 0.6171 0.5349 0.3898
DST (km) 0.7454 0.6000 0.5879 0.8445 0.7000 0.5902 0.3889 0.2700 0.4171
# of obs. 1324 1036 288
a The price is measured based on the evaluation of land per square meter (m2 ). DCBD is the geographical distance
from the center calculated using longitude and latitude. DST is rounded at 0.01 km designates a distance of less than or
equal to 1 km, and all distances above 1 km are rounded at intervals of 0.1 km.

Table 2
Description of the other attributes
Description # of obs. Mean Std. Dev. Min. Max.
ROAD Distance to the closest major 1324 0.317 0.271 0.000 1.665
road (km)
(Highways and National Road)
COAST Distance to the coast (Tokyo 1324 0.640 0.508 0.030 2.031
Bay) (10 km)
PARK Distance to the closest national 1324 0.269 0.154 0.006 1.052
or regional park (km)
SCHOOL Distance to the closest 1324 0.286 0.144 0.008 1.025
elementary or junior high
school (km)
DSCBD Distance to the train or subway 1324 0.893 0.407 0.000 1.868
station that is used by the
largest number of passengers
(Shinjuku Station) (10 km)

Further, when we observe Fig. 2 carefully, we find a “bump” on the west side of the center.
The location of this bump approximately corresponds to Shinjuku Station, which is used by more
passengers than any other station in Japan. We calculated the distance from this second center of
the city and include this variable as one of the determinants of land price and usage.12

4. Estimation result

4.1. The basic model

We estimate the residential and commercial bid rent functions and the location choice function
using the data described above. We call the basic model, which does not contain attributes other
than DCBD and DST, as “Model 1,” and it is estimated using (a) OLS, (b) Heckman’s Model,
(c) FIML-Logit, and (d) FIML-Probit.
The results in Table 3 show that the estimates are similar among estimators for residential
land value function, while they differ for commercial land value function. The difference for

12 The formal discussion for identifying the second center is described in McMillen and Smith [15].
42 S. Muto / Journal of Urban Economics 60 (2006) 33–49

Table 3
Bid rent functions and location choice function (Model 1)
Estimated Independent (a) OLS (b) Heckman (c) FIML-Logit (d) FIML-Probit
vector/matrix variable
γ Constant 0.059 −0.244
(0.136) (0.162)
DCBD 0.116 0.704
(0.364) (0.416)
(DCBD)2 −0.105 −0.369
(0.217) (0.245)
DST −0.460 −0.425
(0.159) (0.166)
(DST)2 0.148 0.149
(0.070) (0.074)
βr Constant 14.056 14.306 13.704 13.985
(0.050) (0.196) (0.050) (0.050)
DCBD −1.495 −1.743 −1.176 −1.424
(0.098) (0.213) (0.095) (0.098)
(DCBD)2 0.590 0.679 0.495 0.564
(0.048) (0.084) (0.044) (0.048)
DST −0.275 −0.380 −0.268 −0.249
(0.036) (0.085) (0.032) (0.036)
(DST)2 0.010 0.038 0.012 0.003
(0.011) (0.024) (0.011) (0.011)
βc Constant 15.392 15.558 15.623 15.748
(0.134) (0.190) (0.150) (0.175)
DCBD −1.641 −2.625 −3.616 −3.571
(0.434) (0.912) (0.475) (0.508)
(DCBD)2 0.340 0.496 1.095 0.969
(0.292) (0.316) (0.310) (0.312)
DST −1.511 −2.614 −3.567 −3.096
(0.235) (0.937) (0.285) (0.246)
(DST)2 0.404 0.650 0.875 0.795
(0.126) (0.236) (0.096) (0.094)

commercial land function is the steepness of the slope or the curve of the price with respect to
the difference from the center (DCBD). The slope of commercial land price is steeper for Heck-
man’s sequential estimator and the FIML than that of the OLS, which suggests the existence of
selectivity biases. We cannot tell whether the FIML or Heckman’s estimator is more “accurate,”
since Heckman’s estimator may be severely affected by its inefficiency, while the estimates of
the FIML may be biased when the actual error structure is different from its assumed structure.
There are also differences in the estimates of γ for DCBD and DCBD2 between the estimates of
the FIML-Logit and the FIML-Probit. This implies that the estimates of these parameters (DCBD
and DCBD2 ) in the usage decision equation are not robust with the assumption on the distribution
of εti .

4.2. Results on land value functions

Next, we add the variables described in Table 2 to Model 1 for the estimation, which is referred
to as Model 2 and 3, and we estimated Model 2 and 3 by Heckman’s sequential estimator and the
 S. Muto / Journal of Urban Economics 60 (2006) 33–49 43

FIML-Logit and the FIML-Probit. Model 2 includes Road, Coast, Park, and School in addition
to the variables for Model 1. For Model 3, we introduce the distance from this second center
(DSCBD) and added to Model 2 for the estimation. Model 4 is estimated with the DCBD and
DSCBD to the third.
The results in Tables 4–6 show that the estimates of Heckman’s estimator and the two FIMLs
are similar for residential and commercial land value functions. Comparing Model 2 and 3, the es-
timates of DSCBD and DSCBD2 are significant at a 5% significance level and the log-likelihood
of the FIML-Logit and FIML-Probit is drastically increased for Model 3. This suggests the ne-
cessity of incorporating the distance from the second city center.
The results also show that the distance from major roads and the coast work negatively for
residential and commercial land prices, while the effect of that distance is larger for commercial
usage than for residential usage and is not always significant for residential usage. The gap be-
tween residential and commercial usage is especially large for the distance from major roads. It
can be said that the accessibility to roads is more important for commercial usage, while resi-
dents do not necessarily favor closeness to major roads due to the noise and exhaust created by
cars and trucks. The closeness to the coast is evaluated positively for residential and commercial
usage even though there is no natural coast or beach in the area used for this paper. We may be
able to say that the coast area provides a scenic view and an attractive environment not only for
residents but for offices and shopping malls as well.

Table 4
Estimates using Heckman’s estimator
Land Model 2 Model 3 (incl. attributes and
value (incl. attributes) distance from the second center)
function Residence Commerce Residence Commerce
14.172 15.161 13.960 16.482
Constant
(0.153) (0.168) (0.111) (0.203)
−1.648 −2.524 −0.653 −3.554
DCBD
(0.177) (0.641) (0.145) (0.565)
0.647 0.516 0.518 1.320
DCBD2
(0.078) (0.290) (0.058) (0.265)
−0.341 −2.282 −0.081 −3.582
DST
(0.068) (0.710) (0.052) (0.616)
0.027 0.579 −0.026 0.874
DST 2
(0.019) (0.186) (0.014) (0.160)
−0.033 −0.889 −0.038 −0.777
ROAD
(0.027) (0.230) (0.020) (0.198)
−0.002 0.013 −0.024 −0.101
COAST
(0.002) (0.027) (0.002) (0.023)
0.080 0.294 0.170 −0.170
PARK
(0.047) (0.264) (0.036) (0.238)
0.158 1.482 0.006 1.886
SCHOOL
(0.060) (0.408) (0.046) (0.362)
−0.860 −2.404
DSCBD
(0.077) (0.343)
0.099 0.851
DSCBD2
(0.034) (0.206)
−0.108 0.643 0.076 1.576
δror δc
(0.093) (0.473) (0.070) (0.403)
Note. Asymptotic standard errors are in parentheses.
44 S. Muto / Journal of Urban Economics 60 (2006) 33–49

Table 5
Estimates of FIML-Logit
Land Model 2 Model 3 (incl. attributes and
value (incl. attributes) distance from the second center)
function Residence Commerce γ Residence Commerce γ
13.645 15.196 −0.013 13.730 16.284 0.953
Constant
(0.052) (0.171) (0.149) (0.040) (0.204) (0.139)
−1.107 −3.110 0.184 −0.298 −2.569 −0.145
DCBD
(0.096) (0.474) (0.383) (0.080) (0.402) (0.316)
0.415 0.827 −0.316 0.336 1.138 0.037
DCBD2
(0.046) (0.317) (0.245) (0.035) (0.272) (0.196)
−0.257 −3.139 −0.309 −0.178 −2.656 −0.251
DST
(0.032) (0.260) (0.150) (0.025) (0.222) (0.133)
0.013 0.757 0.102 −0.003 0.611 0.058
DST 2
(0.010) (0.091) (0.067) (0.008) (0.076) (0.058)
−0.007 −0.808 −0.354 −0.053 −0.464 −0.039
ROAD
(0.023) (0.224) (0.129) (0.016) (0.196) (0.125)
0.009 −0.014 0.042 −0.015 −0.082 0.001
COAST
(0.002) (0.016) (0.010) (0.001) (0.017) (0.010)
−0.029 0.178 0.270 0.086 −0.234 −0.217
PARK
(0.041) (0.303) (0.220) (0.031) (0.245) (0.157)
0.087 1.492 0.029 −0.031 1.127 −0.056
SCHOOL
(0.047) (0.310) (0.210) (0.035) (0.257) (0.148)
−0.839 −2.428 −1.291
DSCBD
(0.059) (0.370) (0.204)
0.117 0.812 0.526
DSCBD2
(0.029) (0.227) (0.139)
5.081 1.523 6.908 1.802
σror σc
(0.118) (0.082) (0.162) (0.096)
Log-likelihood ratio −287.626 −658.211
Note. Asymptotic standard errors are in parentheses.

The closeness to school does not create either a significantly positive or negative effect for
residential usage, but it does have a negative effect for commercial land prices. This can be
explained by the fact that shoppers and offices do not usually try to locate close to schools, and
these places are usually kept quiet and there are less intense commercial activities. The effect
of the closeness to parks for residential usage is somewhat puzzling. While it may be the case
that parks provide amenities to residents and have a positive effect for residential land usage, the
estimated coefficient actually suggests that residents evaluate their land price negatively when
the land is close to parks. Although the reason for this is not clear, we can argue that urban parks
tend to locate far from the places where people, shops, and offices gather, and this is reflected in
the estimates of residential land prices.

4.3. Systematic departure from the bid rent function model

The FIML-Logit and the FIML-Probit can retrieve the estimates of γ in usage decision equa-
tions, which indicate the systematic departure of the land use mechanism from the theoretical
bid rent function model. As shown in Table 5, the estimates for γ are significant at 5% for the
coefficient of DSCBD, DSCBD2 , and the constant term in Model 3 for both the FIML-Logit and
the FIML-Probit.
 S. Muto / Journal of Urban Economics 60 (2006) 33–49 45

Table 6
Estimates of FIML-Probit
Land Model 2 Model 3 (incl. attributes and
value (incl. attributes) distance from the second center)
function Residence Commerce γ Residence Commerce γ
13.930 15.375 −0.244 14.021 16.320 0.633
Constant
(0.055) (0.190) (0.164) (0.044) (0.220) (0.159)
−1.406 −3.224 0.496 −0.730 −2.781 0.415
DCBD
(0.100) (0.490) (0.413) (0.082) (0.420) (0.355)
0.549 0.850 −0.440 0.546 1.130 −0.241
DCBD2
(0.050) (0.305) (0.254) (0.038) (0.269) (0.209)
−0.242 −2.800 −0.261 −0.108 −2.461 −0.272
DST
(0.036) (0.231) (0.164) (0.027) (0.200) (0.139)
0.001 0.713 0.113 −0.019 0.604 0.087
DST 2
(0.011) (0.090) (0.072) (0.008) (0.076) (0.061)
−0.019 −0.805 −0.291 −0.041 −0.486 −0.019
ROAD
(0.026) (0.211) (0.143) (0.020) (0.186) (0.124)
0.003 −0.120 0.497 −0.025 −0.064 0.013
COAST
(0.017) (0.138) (0.098) (0.002) (0.015) (0.010)
0.088 0.194 0.247 0.166 −0.119 −0.160
PARK
(0.047) (0.294) (0.219) (0.035) (0.257) (0.177)
0.106 1.494 −0.057 0.017 1.203 −0.162
SCHOOL
(0.053) (0.308) (0.212) (0.039) (0.270) (0.168)
−0.840 −2.273 −1.343
DSCBD
(0.074) (0.396) (0.246)
0.093 0.813 0.581
DSCBD2
(0.034) (0.219) (0.141)
0.229 0.992 0.171 0.863
σror σc
(0.005) (0.052) (0.004) (0.043)
Log-likelihood ratio −664.76855 −309.60066
Note. Asymptotic standard errors are in parentheses.

Using the parameter of the FIML-Probit, the departure concerning DSCBD indicates that land
within approximately 5 km of the second city center is more likely to be occupied by housing
than the probability that is implied by the difference in the valuation of land. In other words,
some of the land near the second center would have been evaluated higher if it was used by
commercial entities. This phenomenon is not observed vis-à-vis the distance from the first center
(DCBD).
Although the mechanism of this phenomenon is not clear, it might be related to the fact that
the area around Shinjuku was developed relatively recently compared to the first center. The
Shinjuku area was commercially developed beginning in the 1970s, while the first center was de-
veloped long ago and is a traditional business district of Tokyo. It is possible that many residents
or residential landowners around Shinjuku have simply chosen not to change land usage over
the past thirty years or more even though they knew that the commercial valuation of the land
had gone higher. If such a persistence in land usage is severe, this historical difference would
explain why the commercial valuation of land is higher than the theoretically implied value near
the second city center and not around the first.13

13 The log-likelihood for Model 3 is −287.6255 for the FIML-Logit and −309.60066 for the FIML-Probit, and those of
models without Xi are −346.96233 and −341.91049, respectively. The test statistics follow the chi-squared distribution
46 S. Muto / Journal of Urban Economics 60 (2006) 33–49

Regardless of the cause of the effect of the second city center, the systematic departure from
bid rent function theory is quite evident in terms of the likelihood ratio test. The test shows that
including the explanatory variables Xi significantly affects the log likelihood of the estimation.
Further, using the estimates (γ̂ ) of the FIML-Logit and the FIML-Probit for Model 3, we can
retrieve the magnitude of the systematic departure (X γ̂ ), which is shown by the histogram of
Fig. 3. Since we take the log of land price in the equations, the value can be interpreted as the
ratio of the departure from land price around zero. That is, if the value of Xi γ is 0.1 for a parcel
of land i, the probability that the point i is used for residential purposes is 50% if the residential
land value is about 10% lower than the commercial land value.
The results show that the mean value of X γ̂ is close to zero, and it means that the usage of
land in the data area is, on average, not biased in terms of land prices toward either residential
or commercial usage. However, the distribution of X γ̂ suggests that, depending on the distance
from the second city center and the other factors, the usage does not necessarily follow the rule
implied by the bid rent function model.
The analysis in this paper is based on the assumption made for the estimation. That is, the
estimates of the FIML-Probit and the FIML-Logit are accurate if the positive or negative corre-
lation of residential land prices and commercial land prices do not severely affect the estimates.
Moreover, as mentioned earlier, the FIMLs assume that a parcel of land i is not always occupied
by the usage t, even if Vti + Xi γ > Vt  i . We cannot capture such friction if it follows a purely
random process, although we can capture systematic friction by the coefficient γ .

(a) (b)

Fig. 3. Distribution of Xγ and descriptive statistics.

with 11 degrees of freedom, and both are significant with a 1% level of significance. We also performed the likelihood
ratio test that compares the log-likelihood of Model 3 with that of the constrained model where the parameter elements
in γ except for the parameters for DSCBD, DSCBD2 , and the constant. The results show that the inclusion of the explana-
tory variables except for DSCBD, DSCBD2 , and the constant is not significant at the 5% level of significance for both
the FIML-Logit and the FIML-Probit model, while it is significant at the 20% level of significance for the FIML-Logit
and the 10% level of significance for the FIML-Probit.
 S. Muto / Journal of Urban Economics 60 (2006) 33–49 47

These limitations can be an obstacle to an analysis that is useful in reality. For example,
a landlord may want to know whether the land should be used for residential or commercial
purposes. The gain of changing usage can be described as follows:
V = −(Vti − Vt  i ), (13)
t ,
where the current usage is t and the alternate usage is and Vt  i denotes the predicted or latent
value of the land price for usage t  . The mean value and the distribution of V are unreliable if
the model is not consistent with reality. Unfortunately, it is impossible to identify all the para-
meters if we incorporate the positive or negative correlation between εt and εt  , and the random
relationship between land usage and valuation. However, we may be able to infer the distribution
of V based on the identified parameters. Such approach is taken in Poirier and Tobias [17] and
some other papers that take the Bayesian approach, although the implementation is beyond the
scope of this paper.

5. Conclusion

This paper investigates the estimation model of land value and land usage, where two differ-
ent usages are bidding on the land. To estimate the land price evaluation, one possible estimator
is Heckman’s selectivity correction estimator. The other possible estimator is the FIML that is
consistent with the theoretical bid rent function model. This paper develops the FIML, apply-
ing the estimator developed by Lerman and Kern [10]. Using the FIML, land price and location
choice models are estimated for a certain area in Tokyo, Japan. The results show that the dis-
tance from major roads and the coast is negatively evaluated for residential and commercial land
prices. Commercial land usage tends to give greater valuation to such attributes than does resi-
dential usage. The FIML can also capture the systematic departure of the location choice from
the bid rent function model. The results show that the actual land-bidding process is roughly
consistent with the bid rent function model, while there is a statistically significant departure of
the estimated location choice function from the theoretical model. There is a limitation for the
FIML in our model, since it cannot identify the correlation between the valuation of residential
and commercial usage. It also assumes that there is no random market friction for the location
choice.

Acknowledgments

This paper is a part of my PhD dissertation in economics at the University of California, Irvine.
I deeply appreciate the instruction of all the faculty members, but especially that of Professor
Kenneth A. Small, who offered many valuable comments on the paper.

Appendix A. Description of the bivariate nonparametric estimation

The estimation is based on the formulation in Fan and Gijbels [4]. We estimated the relation-
ship of y with x and z without assuming the parametric equation
y = m(x, z) + ε. (A.1)
To perform the bivariate nonparametric regression, where x and z are not correlated with each
other, the estimates are derived from the minimization such that
min(Y − Xβ) W (Y − Xβ)
48 S. Muto / Journal of Urban Economics 60 (2006) 33–49

where

Y = [y1 . . . yN ] ,
⎛ ⎞
1 (x1 − x0 ) · · · (x1 − x0 )p (z1 − z0 ) · · · (z1 − z0 )p
. . . .
X = ⎝ .. .. .. .. ⎠,
1 (xN − x0 ) · · · (xN − x0 ) p (zN − z0 ) · · · (zN − z0 )p




xi − x0 zi − z0
and W = diag KhN · KhN (N × N ).
hx (N ) hz (N )
W is the weight matrix that has a heavier weight on the estimation error ui = yi − xi β when xi is
close to x0 . K(·) denotes the kernel and hx (N ) and hz (N ) are bandwidths for x and z. We used
the Biweight Kernel for this weighing purpose and set both bandwidths as 1.

Appendix B. Description of the calculation of distance data

B.1. DCBD

The center of the city is identified as the highest point of nonparametric regression surface of
land prices using the bivariate nonparametric regression result in Fig. 2. The grid used for the
regression is approximately 300 meters. DCBD is calculated as the geometrical distance between
the center and each data point.

B.2. SCHOOL and PARK

SCHOOL and PARK are calculated as the geometrical distance from each data point to the
closest school and park, respectively. The data used for SCHOOL is the longitude and latitude
data for elementary and junior high schools, which are the institutions for mandatory education
in Japan. The data used for PARK is the longitude and latitude data for urban parks, ball parks,
and other athletic fields.

B.3. ROAD and COAST

ROAD and COAST are calculated as the geometrical distance from each data point to the
closest major road and coastline, respectively. The data used for “major roads” are the highways,
national roads, and Tokyo city roads, and the “coastline” used in this paper is Tokyo Bay.
However, the data of major roads and the coastline contained in the Land Numeric Information
Service consist of the longitude and latitude data for nodes and links and supplemental points.
To calculate the shortest distance to major roads, for example, we used the following algorithm.

(i) For a data point (A) that has land price data, we measured all the distances to all the points
on the major roads.
(ii) We then picked the closest point on the major roads (B) and the second-closest one (C) so
that B and C were located next to each other.
(iii) We then calculated the distance to line BC. That is, ROAD is the length of a vertical line
from A to line BC. (If the intersection of the vertical line from A does not cross BC, B is
picked as the closest point and ROAD is the distance between A and B.)
 S. Muto / Journal of Urban Economics 60 (2006) 33–49 49

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