A Reduced-Form Model for Lease Contract Valuation with Embedded Options

62 Pages Posted: 21 Oct 2011 Last revised: 20 Dec 2017

See all articles by Chuang-Chang Chang

Chuang-Chang Chang

National Central University at Taiwan - Department of Finance

Hsiao-Wei Ho

Shih Chien University

Henry Hongren Huang

National Central University at Taiwan

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York

Date Written: December 19, 2017

Abstract

This paper derives an integrated reduced-form model to calculate the values of adjustable-rate leases with embedded cancellation, purchase, and default options. We also provide numerical examples showing that for a 30-year lease contract, the lessor offers a 15% discount in the initial rent, but charges an additional 33.14% for the cancellation, 12.16% for the purchase, and 20.73% for default options in comparison to the contract without any embedded options. This result suggests that ignoring embedded options in valuing a lease contract leads to significant pricing errors. Thus, we provide a flexible and implementable framework to value complex lease contracts and enhance the efficiency of real-estate lease portfolio management.

Keywords: Lease Contracts, Embedded Options, Default Risk, Adjustable Rate

JEL Classification: G12, G13

Suggested Citation

Chang, Chuang-Chang and Ho, Hsiao-Wei and Huang, Henry Hongren and Yildirim, Yildiray, A Reduced-Form Model for Lease Contract Valuation with Embedded Options (December 19, 2017). Available at SSRN: https://ssrn.com/abstract=1947331 or http://dx.doi.org/10.2139/ssrn.1947331

Chuang-Chang Chang

National Central University at Taiwan - Department of Finance ( email )

No. 300, Jhongda Rd, Jhogli City, Taoyuan, Taiwan,
Jhongli, TY 32001
Taiwan
886-3-4227151 ext. 6159 (Phone)
886-3-4252961 (Fax)

Hsiao-Wei Ho

Shih Chien University ( email )

200 University Road
Ney-Nan Tsun
Kaohsiung, 845
Taiwan

Henry Hongren Huang

National Central University at Taiwan ( email )

No. 300, Zhongda Road
Chung-Li Taiwan, 32054
Taiwan

Yildiray Yildirim (Contact Author)

Zicklin School of Business, Baruch College - The City University of New York ( email )

55 Lexington Ave., Box B13-260
New York, NY 10010
United States

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