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A model for pricing real estate derivatives with stochastic interest rates

Author

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  • Ciurlia, Pierangelo
  • Gheno, Andrea

Abstract

The real estate derivatives market allows participants to manage risk and return from exposure to property, without buying or selling directly the underlying asset. Such market is growing very fast hence the need to rely on simple yet effective pricing models is very great. In order to take into account the real estate market sensitivity to the interest rate term structure in this paper is presented a two-factor model where the real estate asset value and the spot rate dynamics are jointly modeled. The pricing problem for both European and American options is then analyzed and since no closed-form solution can be found a bidimensional binomial lattice framework is adopted. The model proposed allows calibration to the interest rate and volatility term structures.

Suggested Citation

  • Ciurlia, Pierangelo & Gheno, Andrea, 2008. "A model for pricing real estate derivatives with stochastic interest rates," MPRA Paper 9924, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:9924
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    File URL: https://mpra.ub.uni-muenchen.de/9924/1/MPRA_paper_9924.pdf
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    References listed on IDEAS

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    1. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    3. Klaus Sandmann & Dieter Sondermann, 1997. "A Note on the Stability of Lognormal Interest Rate Models and the Pricing of Eurodollar Futures," Mathematical Finance, Wiley Blackwell, vol. 7(2), pages 119-125, April.
    4. 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. Dong Zou & Pu Gong, 2017. "A Lattice Framework with Smooth Convergence for Pricing Real Estate Derivatives with Stochastic Interest Rate," The Journal of Real Estate Finance and Economics, Springer, vol. 55(2), pages 242-263, August.
    2. 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.
    3. 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.

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    More about this item

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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