Urban Spatial Development: a Real Options Approach

We investigate urban spatial development assuming that landowners irreversibly develop property in an uncertain environment. Unlike the standard monocentric city model, we assume that bid rents for houses are not monotonically decreasing with the distance from the central business district (CBD) because there exist subcenters that are subsidiary to the CBD. As a result, land is initially developed outward from the CBD. Leapfrog development may happen, i.e., distant land from the CBD may be developed prior to nearby land; however, land that is developed later will be more densely developed because it is developed at a better state of nature. We further find that the development patterns of at least four large cities are consistent with that predicted by our model.