Risk-Neutral Valuation of Real Estate Derivatives

ORTEC Technical Paper No. 2009-02

32 Pages Posted: 16 Jan 2010 Last revised: 26 Oct 2010

See all articles by David van Bragt

David van Bragt

Ortec Finance

Marc Francke

University of Amsterdam - Faculty of Economics and Business (FEB); Ortec Finance

Bodine Kramer

University of Amsterdam

Antoon Pelsser

Maastricht University; Netspar

Multiple version iconThere are 2 versions of this paper

Date Written: October 25, 2010

Abstract

We propose a new and intuitive risk-neutral valuation model for real estate derivatives which are linked to autocorrelated indices. We model the observed index with an autoregressive model which can be estimated using standard econometric techniques. The resulting index behavior can easily be analyzed and closed-form pricing solutions are derived for forwards, swaps and European put and call options. We demonstrate the application of the model by valuing a put option on a house price index. Autocorrelation in the index returns appears to have a large impact on the option value. We also study the effect of an over- or undervalued real estate market. The observed effects are significant and as expected.

Keywords: Real estate derivatives, Option pricing, Incomplete markets, Price discovery, Autoregressive models, Seasonality, Stochastic volatility

JEL Classification: C51, D52, G13

Suggested Citation

Bragt, David van and Francke, Marc and Kramer, Bodine and Pelsser, Antoon A. J., Risk-Neutral Valuation of Real Estate Derivatives (October 25, 2010). ORTEC Technical Paper No. 2009-02. Available at SSRN: https://ssrn.com/abstract=1536394 or http://dx.doi.org/10.2139/ssrn.1536394

David van Bragt

Ortec Finance ( email )

Max Euwelaan 78
Rotterdam, 3062 MA
Netherlands
+31 (0)10 498 66 66 (Phone)
+31 (0)10 498 66 67 (Fax)

HOME PAGE: http://www.ortec-finance.com

Marc Francke

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Plantage Muidergracht 12
Amsterdam, 1018 TV
Netherlands

HOME PAGE: http://www.uva.nl/en/contact/staff/item/m.k.francke.html?f=francke

Ortec Finance ( email )

Orly Centre
Barajasweg 10
Amsterdam, 1043 CP
Netherlands
+ 31 20 7009 700 (Phone)
+ 31 20 7009 701 (Fax)

HOME PAGE: http://www.ortec-finance.com

Bodine Kramer

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

Antoon A. J. Pelsser (Contact Author)

Maastricht University ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

HOME PAGE: http://https://sites.google.com/site/apelsseraca/

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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