Empirical Estimation of the Option Premium for Residential Redevelopment

Posted: 22 May 2009 Last revised: 1 Nov 2011

See all articles by John M. Clapp

John M. Clapp

University of Connecticut - Department of Finance

Katsiaryna Salavei Bardos

Fairfield University - Department of Finance

Siu Kei Wong

University of Hong Kong

Date Written: September 20, 2010

Abstract

This paper presents and validates a novel empirical approach for measuring the value of the option to redevelop using a standard hedonic dataset. Our analysis generalizes the standard hedonic model to account for the option value of reconfiguring hedonic characteristics. We test this model with over 162,000 real estate transactions in 53 towns in Connecticut between 1994 and 2007 by adding a non-linear intensity variable, which increases with the aggregate value of structure and decreases with land value. A conservative estimate is that about 20% of towns have significantly positive option value, with a mean value of 29-34% for properties most like vacant land. Multiple tests across towns support predictions of real options theory. Positive option value towns have higher house price volatility and estimated option value varies positively with price volatility, a finding inconsistent with NPV theory. We also find positive association between option value and drift in house prices and a U-shape relation with house price adjusted for structural characteristics. Higher property taxes reduce the value of option to redevelop.

Keywords: real options, hedonic pricing, housing redevelopment, house price volatility

Suggested Citation

Clapp, John M. and Bardos, Katsiaryna Salavei and Wong, Siu Kei, Empirical Estimation of the Option Premium for Residential Redevelopment (September 20, 2010). Regional Science and Urban Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1408175

John M. Clapp (Contact Author)

University of Connecticut - Department of Finance ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States
860-486-5057 (Phone)
860-486-0349 (Fax)

Katsiaryna Salavei Bardos

Fairfield University - Department of Finance ( email )

Dolan School of Business
1073 North Benson Road
Fairfield, CT 06824
United States

Siu Kei Wong

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, HK
China

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