Irreversible Investment, Real Options, and Competition: Evidence from Real Estate Development

37 Pages Posted: 29 Sep 2006 Last revised: 15 Aug 2010

See all articles by Laarni T. Bulan

Laarni T. Bulan

Cornerstone Research

Christopher J. Mayer

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

C. Tsuriel Somerville

University of British Columbia (UBC) - Division of Strategy and Business Economics

Multiple version iconThere are 3 versions of this paper

Date Written: August 2006

Abstract

We examine the extent to which uncertainty delays investment and the effect of competition on this relationship using a sample of 1,214 condominium developments in Vancouver, Canada built from 1979-1998. We find that increases in both idiosyncratic and systematic risk lead developers to delay new real estate investments. Empirically, a one-standard deviation increase in the return volatility reduces the probability of investment by 13 percent, equivalent to a 9 percent decline in real prices. Increases in the number of potential competitors located near a project negate the negative relationship between idiosyncratic risk and development. These results support models in which competition erodes option values and provide clear evidence for the real options framework over alternatives such as simple risk aversion.

Suggested Citation

Bulan, Laarni Tobia and Mayer, Christopher J. and Somerville, C. Tsuriel, Irreversible Investment, Real Options, and Competition: Evidence from Real Estate Development (August 2006). NBER Working Paper No. w12486. Available at SSRN: https://ssrn.com/abstract=926064

Laarni Tobia Bulan

Cornerstone Research ( email )

Boston, MA
United States

Christopher J. Mayer (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

C. Tsuriel Somerville

University of British Columbia (UBC) - Division of Strategy and Business Economics ( email )

2053 Main Mall
Vancouver, British Columbia
Canada
604-822-8341 (Phone)
604-822-8351 (Fax)

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