Risk-Neutral Valuation of Real Estate Derivatives
Ortec Finance Research Center Technical Paper No. 2009-02
Posted: 20 May 2019
Date Written: October 1, 2009
We propose a novel and intuitive risk-neutral valuation model for real estate derivatives. We first model the underlying efficient market price of real estate and then construct the observed index value with an adaptation of the price update rule by Blundell and Ward (1987). 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