Hedonism vs. nihilism: No arbitrage and tests of urban economic models

We present two notions of “no arbitrage” in urban economic models and show that there is no model satisfying both. The standard hedonic housing model of urban economics and its generalizations are consistent with the first of these, but inconsistent with the second. We present a model consistent with the second notion of “no arbitrage” and a continuum of models consistent with neither notion that are observationally equivalent to the standard model, even if the utility function of consumers is known. Only one of these is the standard model. Thus, the available tests of the standard model cannot provide much evidence of its validity. Finally, we examine nonlinear price systems consistent with the second notion of “no arbitrage” and their welfare consequences.