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We reexamine the relationship between quality of public schools and house prices and find it to be nonlinear. Unlike most studies in the literature, we find that the price premium parents must pay to buy a house in an area associated with a better school increases as school quality increases. This is true even after controlling for neighborhood characteristics, such as the racial composition of neighborhoods, which is also capitalized into house prices. In contrast to previous studies that use the boundary discontinuity approach, we find that the price premium from school quality remains substantially large, particularly for neighborhoods associated with high-quality schools.
(JEL C21, 120, R21)
Federal Reserve Bank of St. Louis Review, May/June 2010, 92(3), pp. 185-204.
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The relationship between house prices and local public goods and services has been widely studied in the literature, dating back to Oates's (1969) seminal paper, in which he studied the effect of property tax rates and public school expenditures per pupil on house prices. Oates conjectured that if, according to the Tiebout (1956) model, individuals consider the quality of local public services in making locational decisions, an increase in expenditures per pupil should result in higher property values, whereas an increase in property tax rates would result in a decline in property values, holding other things equal across communities. Oates suggested that the variation in expenditures per pupil partially reflected the variation in the quality of public schools.
In the analysis of school quality, researchers have often applied the hedonic pricing model developed by Rosen (1974). In this model, the implicit price of a house is a function of its comparable characteristics, as well as measures of school quality and a set of neighborhood characteristics. A house's comparable characteristics include the number of bedrooms, square footage, and so on. The estimated coefficients from the regression represent the capitalization of the different components into house values.
In an influential study, Black (1999) argued that previous research estimating hedonic pricing functions introduced an upward bias from neighborhood quality effects that are unaccounted for in the data.1 Specifically, she noted that better schools may be associated with better neighborhoods, which could independently contribute to higher house prices. Black circumvented this problem by estimating...