Risk-Neutral Valuation of Real Estate Derivatives
ORTEC Technical Paper No. 2009-02
32 Pages Posted: 16 Jan 2010 Last revised: 26 Oct 2010
Date Written: October 25, 2010
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: Suggested Citation