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A Note on the Pricing of Real Estate Index Linked Swaps

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  • Björk, Tomas

    (Dept. of Finance, Stockholm School of Economics)

  • Clapham, Eric

    (Dept. of Finance, Stockholm School of Economics)

Abstract

In this paper we discuss the pricing of commercial real estate index linked swaps (CREILS). This particular pricing problem has been studied by Buttimer et al. (1997) in a previous paper. We show that their results are only approximately correct and that the true theoretical price of the swap is in fact equal to zero. This result is shown to hold regardless of the specific model chosen for the index process, the dividend process, and the interest rate term structure. We provide an intuitive economic argument as well as a full mathematical proof of our result. In particular we show that the nonzero result in the previous paper is due to two specific numerical approximations introduced in that paper, and we discuss these approximation errors from a theoretical as well as from a numerical point of view.

Suggested Citation

  • Björk, Tomas & Clapham, Eric, 2002. "A Note on the Pricing of Real Estate Index Linked Swaps," SSE/EFI Working Paper Series in Economics and Finance 492, Stockholm School of Economics.
    • Handle: RePEc:hhs:hastef:0492
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    1. Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
    2. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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    Cited by:

    1. Frank Fabozzi & Robert Shiller & Radu Tunaru, 2009. "Property Derivatives for Managing European Real-Estate Risk," Yale School of Management Working Papers amz2652, Yale School of Management, revised 01 Sep 2009.
    2. Gong, Pu & Zou, Dong & Wang, Jiayue, 2018. "Pricing and simulation for real estate index options: Radial basis point interpolation," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 500(C), pages 177-188.
    3. Frank J. Fabozzi & Robert J. Shiller & Radu S. Tunaru, 2012. "A Pricing Framework for Real Estate Derivatives," European Financial Management, European Financial Management Association, vol. 18(5), pages 762-789, November.
    4. Gong, Pu & Dai, Jun, 2017. "Pricing real estate index options under stochastic interest rates," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 479(C), pages 309-323.
    5. Frank Fabozzi & Robert Shiller & Radu Tunaru, 2009. "Property Derivatives for Managing European Real-Estate Risk," Yale School of Management Working Papers amz2652, Yale School of Management, revised 01 Sep 2009.
    6. Kanak Patel & Ricardo Pereira, 2008. "Pricing Property Index Linked Swaps with Counterparty Default Risk," The Journal of Real Estate Finance and Economics, Springer, vol. 36(1), pages 5-21, January.
    7. Colin Lizieri & Gianluca Marcato & Paul Ogden & Andrew Baum, 2012. "Pricing Inefficiencies in Private Real Estate Markets Using Total Return Swaps," The Journal of Real Estate Finance and Economics, Springer, vol. 45(3), pages 774-803, October.
    8. Juerg Syz & Paolo Vanini, 2011. "Arbitrage Free Price Bounds for Property Derivatives," The Journal of Real Estate Finance and Economics, Springer, vol. 43(3), pages 281-298, October.
    9. Frank J. Fabozzi & Robert J. Shiller & Radu S. Tunaru, 2010. "Property Derivatives for Managing European Real†Estate Risk," European Financial Management, European Financial Management Association, vol. 16(1), pages 8-26, January.
    10. Pierre-Arnaud Drouhin & Arnaud Simon & Yasmine Essafi, 2016. "Forward Curve Risk Factors Analysis in the UK Real Estate Market," The Journal of Real Estate Finance and Economics, Springer, vol. 53(4), pages 494-526, November.
    11. Sebastian, Steffen P. & Steininger, Bertram I., 2021. "Real estate ETNs in strategic asset allocation," Working Paper Series 21/8, Royal Institute of Technology, Department of Real Estate and Construction Management & Banking and Finance.
    12. Frank J. Fabozzi & Robert J. Shiller & Radu S. Tunaru, 2020. "A 30-Year Perspective on Property Derivatives: What Can Be Done to Tame Property Price Risk?," Journal of Economic Perspectives, American Economic Association, vol. 34(4), pages 121-145, Fall.
    13. Ming Pu & Gang-Zhi Fan & Seow Ong, 2012. "Heterogeneous Agents and the Indifference Pricing of Property Index Linked Swaps," The Journal of Real Estate Finance and Economics, Springer, vol. 44(4), pages 543-569, May.
    14. Frontczak, Robert & Rostek, Stefan, 2015. "Modeling loss given default with stochastic collateral," Economic Modelling, Elsevier, vol. 44(C), pages 162-170.
    15. Yoshiki Kago & Charles W.R. Ward, 2008. "Hedging Effectiveness Of Total Returns Swaps: Application To The Japanese Market," ERES eres2008_169, European Real Estate Society (ERES).
    16. Drouhin, Pierre-Arnaud, 2012. "Caractéristiques statistiques et dynamique de prix des produits dérivés immobiliers," Economics Thesis from University Paris Dauphine, Paris Dauphine University, number 123456789/10918 edited by Batsch, Laurent.

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    More about this item

    Keywords

    Real estate; index linked swaps; arbitrage;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • L85 - Industrial Organization - - Industry Studies: Services - - - Real Estate Services

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