Optimism-Driven Decisions of Real Estate Developers Under Demand Uncertainty

53 Pages Posted: 14 Aug 2018 Last revised: 9 Feb 2021

See all articles by Nicole Xu

Nicole Xu

The People's Bank of China (PBC)

Rose Neng Lai

University of Macau

Date Written: April 1, 2018

Abstract

We develop a set of theoretical models to show how differences in real estate developers' optimism about market demand affects construction and sales decisions. The model is a variation of asymmetric Cournot duopoly where developers choose levels of output conditioned on their rivals’ output and their own levels of optimism in a stochastic environment. The resulting Nash equilibrium is used to analyze effects of differences in optimism across developers and sales levels after the realization of stochastic demand. Our analysis shows that optimistic developers construct more housing and hold more inventories when facing higher demand uncertainty. Developers’ overconfidence creates value in terms of optimal profit and market share. We also discuss how updating beliefs over multi-periods could turn a pessimistic developer to an optimistic one, and vice versa. The paper thus provides some behavioral insights into puzzling phenomena such as overconfidence, overbuilding, construction timing, and inventory holding.

Keywords: Optimism, Demand Uncertainty, Heterogeneous Beliefs, Real Estate Developers

JEL Classification: D03, D43, R21, R31, R38

Suggested Citation

Xu, Rui Hui and Lai, Rose Neng, Optimism-Driven Decisions of Real Estate Developers Under Demand Uncertainty (April 1, 2018). Xu, Ruihui and Rose Neng Lai. (2018). Optimism-driven Decisions of Real Estate Developers Under Demand Uncertainty, Journal of Real Estate Research, 40(2), 267-308. , Available at SSRN: https://ssrn.com/abstract=3216003

Rui Hui Xu

The People's Bank of China (PBC) ( email )

No.32 Chengfang Street
Xi Cheng, Beijing 100800
China

Rose Neng Lai (Contact Author)

University of Macau ( email )

Av. Da Universidade, Taipa
Macau, Nil
Macau

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