The Role of Uncertainty in Investment: An Examination of Competing Investment Models Using Commercial Real Estate Data

Abstract

Neoclassical investment decision criteria suggest that only the systematic component of total risk affects the rate of investment, as channeled through the built‐asset price. Alternatively, option‐based investment models suggest a direct role for total uncertainty in investment decisionmaking. To sort out uncertainty's role in investment, we specify and empirically estimate a structural model of asset‐market equilibrium. Commercial real estate time‐series data with two distinct measures of asset price and uncertainty are used to assess the competing investment models. Empirical results generally favor predictions of the option‐based model and hence suggest that irreversibility and delay are important considerations to investors. Our findings also have implications for macroeconomic policy and for forecasts of cyclical investment activity.

The Valuation of Hope Value for Real Estate Development

“…CAPOZZA AND SICK (1994) combined option theory with monocentric urban economic theory. GRENADIER (1995) uses real option theory to explain the cyclical behavior of the real estate market, while HOLLAND (HOLLAND et al 2000) explained cyclical dynamics or the real estate market using a general equilibrium model obtained using the real option. In this context, the waiting option shows an important role in the decisional process of the market player.…”

On demand: Cross-country evidence form Commercial Real Estate Asset Markets

“…Interest rate, expected rental growth, systematic risk and total asset price uncertainty are traditionally modeled as being embedded in built asset price, and therefore are often omitted in supply equation specifications (see, e.g., Wheaton (1987), Wheaton and Torto (1990) for applications to commercial real estate). In contrast, we include explicit measures of these variables in our specification, as Holland et al (2000) and Yoshida (1999) provide evidence that these variables exert a price-independent effect on irreversible investment vis-à-vis the option value of delay.…”

Time-To-Plan Lags for Commercial Construction Projects

“…For applications to commercial real estate, see Holland, Ott, and Riddiough (2000) and Sivitanidou and Sivitanides (2000). 4 For estimates of gestation lags from investment models, see Oliner, Rudebusch, and Sichel (1995), Zhou (2000), Koeva (2001), Millar (2005a), and Del Boca et al (2008); for estimates from dynamic factor demand models, see Palm, Peeters, and Pfann (1993) and Peeters (1998); and for estimates from business cycle models, see Altug (1989) and Christiano and Vigfusson (2003).…”