Home • PRRES Inc. Journal • Read the Journal

Equilibrium Option Pricing Model Under A Specific System: A View on China’s Housing Boom

Author/s: Guo Xiaoyang, Liu Hongyu

Date Published: 1/01/2012

Published in: Volume 18 - 2012 Issue 3 (pages 213 - 230)

Abstract

For real estate markets, especially emerging economies with a specific system, it is essential to focus on the reasonableness of the theoretical hypothesis underpinning the real option pricing model, prior to considering application in valuation and investment. In this paper, we focus on this first-step issue in the context of the Land Finance System in China. Compared with the classic hypothesis, for which the underlying housing price is exogenous to the value of the to-be-developed vacant land, the Land Finance System in China impairs this exogeneity to some extent by the interaction between land value and housing market price. Considering such relationships, we expand the classic option pricing model into a succinct equilibrium model where both the land value and the housing market price are determined simultaneously. The effect of the Land Finance System is reflected as a parameter ?, similar to the parameter ? that reflects the housing market volatility. Numerical analysis is conducted to investigate the nature of the effect of the system parameter ? and the market parameter ? on the variations of both the expected land value and housing market price. Finally, conclusions are drawn concerning an explanation of the housing boom in terms of a system effect.

Download Full Article

Download the Full Article PDF

14445921.2012.11104360.pdf 14445921.2012.11104360.pdf (2MB)

Keywords

China - Housing Market - Land Finance System - Land Valuation - Real Option

References

  • Abel, AB, Dixit, AK, Eberly, JC and Pindyck, RS 1996, ‘Options, the value of capital, and investment’, The Quarterly Journal of Economics, 111, pp. 753–777
  • Aslund, O, Osth, J and Zenou, Y 2009, ‘How important is access to jobs? Old question—improved answer’, Journal of Economic Geography, 10(3), pp. 389–422
  • Bulan, L, Mayer, C and Somerville, CT 2009, ‘Irreversible investment, real options, and competition: Evidence from real estate development’, Journal of Urban Economics, 65, pp. 237–251
  • Capozza, D and Li, Y 1994, ‘The intensity and timing of investment: the case of land’, American Economic Review, 84, pp. 889–904
  • Capozza, DR and Helsley, RW 1990, ‘The stochastic city’, Journal of Urban Economics, 28, pp. 187–203
  • Cheshire, P and Sheppard, S 1995, ‘On the price of land and the value of amenities’, Economica, 62, pp. 247–267
  • Cunningham, CR 2006, ‘House price uncertainty, timing of development, and vacant land prices: evidence for real options in Seattle’, Journal of Urban Economics, 59, pp. 1–31
  • Ding, W, Zheng, S and Guo, X 2010, ‘The value of access to jobs and amenities: evidence for new residential properties in Beijing’, Tsinghua Science and Technology, 15, pp. 595–603
  • Fisher, LM, Pollakowski, HO and Zabel, J 2009, ‘Amenity-based housing affordability indexes’, Real Estate Economics, 37, pp. 705–746
  • Grovenstein, RA, Kau, JB and Munneke, HJ 2011, ‘Development value: a real options approach using empirical data’, The Journal of Real Estate Finance and Economics 43(3), pp. 321–335
  • Gyourko, J, Kahn, M and Tracy, J 1999, ‘ Quality of life and environmental comparisons’, Handbook of Regional and Urban Economics, 3, pp. 1413–1454
  • Harchaoui, TM and Lasserre, P 2001, ‘Testing the option value theory of irreversible investment’, International Economic Review, 42, pp. 141–166
  • Heckman, JJ 1979, ‘Sample selection bias as a specification error’, Econometrica: Journal of the Econometric Society, pp. 153–161
  • Hess, DB and Almeida, TM 2007, ‘Impact of proximity to light rail rapid transit on station-area property values in Buffalo, New York’, Urban Studies, 44, pp. 1041–1068
  • Holland, A, Ott, S and Riddiough, T 2000, ‘ The role of uncertainty in investment: an examination of competing investment models using commercial real estate data’, Real Estate Economics, 28, pp. 33–64
  • Hull, J 2009, Options, futures and other derivatives, Pearson Prentice Hall
  • Kim, J and Zhang, M 2005, ‘Determining transit’s impact on Seoul commercial land values: an application of spatial econometrics’, International Real Estate Review, 8, pp. 1–26
  • Krychowski, C and Quélin, BV 2010, ‘Real options and strategic investment decisions: can they be of use to scholars?’, Academy of Management Perspectives, 24(2), pp. 65–78
  • McDonald, R and Siegel, D 1986, ‘The value of waiting to invest’, The Quarterly Journal of Economics, 101.
  • Quigg, L 1993, ‘Empirical testing of real option-pricing models’, The Journal of Finance, 48, pp. 621–640
  • Rochaa, K, Sallesb, L, Garciab, FAA 2007, ‘Real estate and real options: a case study’, Emerging Markets Review, 8(1), pp. 67–79
  • Rhys, H, Song, J and Jindrichovska, I 2002, ‘The timing of real option exercise: some recent development’, The Engineering Economist, 47, pp. 436–450
  • Sing, TF and Patel, K 2001, ‘Evidence of irreversibility in the UK property market’, The Quarterly Review of Economics and Finance, 41, pp. 313–334
  • Titman, S 1985, ‘Urban land prices under uncertainty’, American Economic Review, 75, pp. 505–514.
  • Trigeorgis, L 1996, Real Options, MIT Press, Cambridge
  • Williams, JT 1991, ‘Real estate development as an option’, Journal of Real Estate Finance and Economics, 4, pp. 191–208
  • Williams, JT 1993, ‘Equilibrium and options on real assets’, Review of Financial Studies, 6, pp. 825–850
  • Yamazaki, R 2001, ‘Empirical testing of real option pricing models using land price index in Japan,’ Journal of Property Investment and Finance, 19, pp. 53–72
  • Zheng, S and Kahn, ME 2008, ‘Land and residential property markets in a booming economy: new evidence from Beijing’, Journal of Urban Economics, 63, pp. 743–757