PR – A Model Of Land Bid Values In Times Of Market Exuberance (p359-365)
Historically, market exuberance can be a major problem in farmland pricing. The objective of this paper is to examine possible underlying mechanisms that result in irrational market exuberance for teaching and extension. Price expectations are examined as a possible underlying cause and rejected. Based on extensive experience with farmers, two alternative bid models are developed based on future farmland values: exogenous and endogenous ending farmland prices. Both models are based on a capital investment model of a farm business which includes farm business financing, cash flows, income taxes and a finite time horizon. The latter requires assets to be valued and tax implications calculated. The exogenous model assumes that ending farmland values are a function of current market values inflated to a future value. The endogenous model assumes that ending farmland values are a function of the bid value itself inflated to some future value. Both models require the use of an algorithm such as Goal Seek© to find the appropriate bid price. A case farm is set up and the bid prices estimated under a range of expected future land inflation rates. As expected, the exogenous model does not display irrational market exuberance; the endogenous model does when the inflation rate approaches the after-tax cost of capital and the bid value becomes infinite. Hence, in times of extreme market exuberance the result is “the more that is bid for land, the more it is worth”. This shows the caution (and discipline) that must be used in times of rapidly inflating land prices.
Keywords: Farmland valuation, bid values, market exuberance
Organizations(s): University of Saskatchewan