Risk-Neutral Valuation of Real Estate Derivatives

Bragt, David van; Francke, Marc; Kramer, Bert; Pelsser, Antoon

doi:10.3905/jod.2015.23.1.089

Cited by 14 publications

(3 citation statements)

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“…Since then, the real options approach has been used in many studies for setting the prices of various investments in real estates. Bragt et al [25] in their study created a risk-neutral valuation model for real estate derivatives based on the real estate index process and derived valuation equations for forwards, swaps, and options on this index. They apply their approach to evaluate the Dutch real estate market.…”

Section: Literature Reviewmentioning

confidence: 99%

Sustainable Value of Investment in Real Estate: Real Options Approach

et al. 2018

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The issue of application of real option valuation approach in the valuation of investment project is presented in the article in a way in which the flexibility of the project could be included in the process of its valuation. The authors apply the valuation approach in case of a specific investment project in the real estate in the capital city of the Czech Republic—Prague, using the option to expand, to contract, and to abandon the project. The main aim of this case study is to present a practical application of the investment valuation and to construct an option pricing model for real estate investment which considers and integrates as many aspects of the investment and market environment as possible to describe the best situation of the real estate market and its development. The valuation of the investment is carried out using a universally applicable numerical method of binomial trees. The results obtained are subjected to the sensitivity analysis with respect to the discount rate, value of the most influential parameter of the volatility and the input option parameters. The results of the valuation of the project obtained using the real option approach are important mainly for the management of the company in the process of quantification of the present value of future investments. Implementation of managerial interventions enables for optimizing the value of the project not only in case of favourable development of the real estate market, but particularly in case of unfavourable development. Therefore, they are important in order to protect an investor from potential high losses. Finally, the valuation of these interventions increases the present value of the project, contributing to the decision of the corporate management regarding its implementation.

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Section: Literature Reviewmentioning

confidence: 99%

Sustainable Value of Investment in Real Estate: Real Options Approach

et al. 2018

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“…Furthermore, direct RE is modeled using a special purpose model, which is based on the Heston Hull-White model, where we explicitly model auto-correlation in the returns (see for more information van Bragt et al (2009)). The investment category MSCI Europe stocks is also modeled by a Heston Hull-White model and is, for simplicity, calibrated to the historical volatility.…”

Section: Valuation Of the Indexation Provision Of A Pension Fundmentioning

confidence: 99%

Pricing inflation products with stochastic volatility and stochastic interest rates

Singor

Grzelak

Bragt

et al. 2013

Insurance: Mathematics and Economics

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We consider a Heston type inflation model in combination with a Hull-White model for nominal and real interest rates, in which all the correlations can be non-zero. Due to the presence of the Heston dynamics our derived inflation model is able to capture the implied volatility skew/smile, which is present in the inflation option market data. We derive an efficient approximate semi-closed pricing formula for two types of inflation dependent options: index and year-on-year inflation options. The derived pricing formulas allow for an efficient calibration of the inflation model. We also illustrate our approach using a real-life pension fund example, where the Heston Hull-White model is used to determine the value of conditional future indexations.

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“…Following Case Jr et al (1993), some real estate researchers have studied in details the nature of risk associated with house prices, while others have investigated the pricing and applicability of the proposed derivatives (see Sommervoll and de Haan, 2014, for a historic discussion of home-value insurance policies). Iacoviello and Ortalo-Magne (2003), for example, investigated the hedging benefits of real estate properties in London, whereas Van Bragt et al (2015) explored the risk-neutral valuation framework as pricing method for these insurance products.…”

Section: Introductionmentioning

confidence: 99%

Diffusion and Risks of House Prices in the Netherlands

Teye

2018

Architecture and the Built Environment

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The rate of home-ownership has increased significantly in many countries over the past decades. One motivating factor for this increase has been the creation of wealth through the accumulation of housing equity, which also forms the basic tenet of the asset-based welfare system. In generating the home equity, house price developments play an important role. Generally, house prices show an increasing trend over long time period, however, there are short-term negative appreciations that may have inherent risks for the housing equity. Following the 2007-08 Global Financial Crisis (GFC), for example, the collapse of house prices has caused many recent home buyers to run into negative equity. Some housing researchers and experts have suggested that a better understanding of the spatial diffusion mechanisms of house prices will aid resuscitating the housing market after the GFC. Others also advocated adopting insurance schemes to protect the home equity that yields the welfare benefits. Unfortunately, however, little research insight exists on the Dutch house price diffusion process, although there are empirical results for countries such as the UK, US and China, where the contexts differ from the Netherlands. Furthermore, the current existing home-value insurance scheme in the literature is found to be less efficient and eliminates only up to 50% of the house price risks. This dissertation covers important aspects of house price diffusion and risks in the Netherlands. The aim is to better understand the diffusion mechanism and the risks of house prices, while it also contributes to the measurement of these housing risks. More specifically, there are three objectives: first, to discover the diffusion mechanism of house prices in the Netherlands and the pattern particularly from the capital Amsterdam; second, to examine the spatial distribution of the house price risk; and third, to investigate the efficiency of the index-based home-value insurance for reducing the house price risk in the Dutch context. The diffusion mechanism relates to the so-called ripple or spillover effect, for which movements of house prices in one location temporarily or permanently spread over their influence to other regions. The risks analyses capture the probability of selling the residential property below the purchase price. The index-based home-value insurance scheme is concerned with the reduction of the house price risk, while its efficiency and loss coverage are analysed. The contributions of the dissertation are specifically elaborated in five chapters. The chapters are self-contained, four of them having been published separately in international journals and the other being currently under review. Chapter 2 is a literature study that presents the general trend and an overview of the risks in home-ownership. It particularly discusses the government mortgage guarantee and tax deduction, among other factors, which contribute to home-ownership in the Netherlands. Mortgage default risk and house price risk, which are the two important risks from the perspective of the home-owners are also discussed in the context of the Dutch market. Chapter 3 investigates the house price diffusion mechanism between the twelve provinces in the Netherlands. The methodology adopts a new Bayesian graphical approach which enables a data-driven identification of the important regions where the diffusion may predominantly emerge. Using quarterly house price indexes, the findings suggest that house price diffusion exists in the Netherlands with a pattern varying over the period of time. Focusing specifically on the period prior to the 2007-2008 Global Financial Crisis (GFC), the house price diffusion predominantly originated from Noord-Holland. House prices in Amsterdam – the capital and an important economic hub of the Netherlands, are more likely to diffuse to other parts of the country. Thus in Chapter 4, attention is paid to the house price diffusion pattern from the capital Amsterdam to the other Dutch regional housing markets. The Granger causality and cointegration techniques are used, while controlling for the important house price fundamentals. The results suggest a possible house price diffusion existing from Amsterdam to all regions in the Netherlands except for Zeeland. The strongest long-run impact of Amsterdam house price diffusion potentially occur in Utrecht. As one of the largest and most dynamic in the Netherlands, the Amsterdam housing market is itself an interesting case study. One part of Chapter 5, therefore, deals with the diffusion pattern by studying the spatial interrelationships between house prices in Amsterdam. The other part of the chapter studies the house price risks. Using the Granger causality test, a general causal flow of house prices is observed from the central business districts to the peripherals. Simple statistics similarly reveal that house prices grow faster and are more risky in the central business districts than those on the peripherals of the city. Chapter 6 is concerned with the efficiency and loss coverage of the index-based home-value insurance scheme. It proposes a modification of the index-based home-value insurances policy, which seeks to reduce the large idiosyncratic residual house price risks. The modification uses aggregate measures of the reference index. Using the hedonic and repeated sales indexes, the empirical analysis suggests the proposed modified scheme is highly efficient and may eliminate up to 70% of the residual risks. In general, the dissertation adopts innovative empirical methodological approach that combines standard statistical analyses and more recent and complex econometric modelling techniques in the study of the diffusion and risks of house prices in the Netherlands. The application of the graphical approach to the study of diffusions particularly in Chapter 3, is the first of its kind in the context of the housing market. Furthermore, this dissertation is among the first to entirely provide a comprehensive analysis and the much needed body of knowledge regarding the house price diffusion and risks for the highly regulated Dutch housing market. The results have important policy implications and applications for households, commercial investors and financial institutions in the Netherlands. The results may also generally apply and replicable in other countries and economies with similar housing market conditions.

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Risk-Neutral Valuation of Real Estate Derivatives

Cited by 14 publications

References 50 publications

Sustainable Value of Investment in Real Estate: Real Options Approach

Sustainable Value of Investment in Real Estate: Real Options Approach

Pricing inflation products with stochastic volatility and stochastic interest rates

Diffusion and Risks of House Prices in the Netherlands

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