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The Role of Uncertainty in Investment: An Examination of Competing Investment Models Using Commercial Real Estate Data

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  • A. Steven Holland
  • Steven H. Ott
  • Timothy J. Riddiough
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    Abstract

    Neoclassical investment decision criteria suggest that only the systematic component of total risk affects the rate of investment, as channeled through the built-asset price. Alternatively, option-based investment models suggest a direct role for total uncertainty in investment decisionmaking. To sort out uncertainty's role in investment, we specify and empirically estimate a structural model of asset-market equilibrium. Commercial real estate time-series data with two distinct measures of asset price and uncertainty are used to assess the competing investment models. Empirical results generally favor predictions of the option-based model and hence suggest that irreversibility and delay are important considerations to investors. Our findings also have implications for macroeconomic policy and for forecasts of cyclical investment activity. Copyright American Real Estate and Urban Economics Association.

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    Bibliographic Info

    Article provided by American Real Estate and Urban Economics Association in its journal Real Estate Economics.

    Volume (Year): 28 (2000)
    Issue (Month): 1 ()
    Pages: 33-64

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    Handle: RePEc:bla:reesec:v:28:y:2000:i:1:p:33-64

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    Cited by:
    1. Steven Ott & W. Hughen & Dustin Read, 2012. "Optimal Phasing and Inventory Decisions for Large-Scale Residential Development Projects," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 45(4), pages 888-918, November.
    2. Laarni Bulan & Christopher Mayer & C. Tsuriel Somerville, . "Irreversible Investment, Real Options, and Competition: Evidence from Real Estate Development," Zell/Lurie Center Working Papers 391, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania.
    3. William Miles, 2009. "Irreversibility, Uncertainty and Housing Investment," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 38(2), pages 173-182, February.
    4. Davis, Graham A. & Cairns, Robert D., 2012. "Good timing: The economics of optimal stopping," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 36(2), pages 255-265.
    5. W. Bowman Cutter & Sofia F. Franco, 2012. "The uneasy case for lower Parking Standards," FEUNL Working Paper Series wp564, Universidade Nova de Lisboa, Faculdade de Economia.
    6. Yuming Fu & Maarten Jennen, 2009. "Office Construction in Singapore and Hong Kong: Testing Real Option Implications," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 38(1), pages 39-58, January.
    7. Frank Packer & Timothy Riddiough, 2012. "Securitisation and the Commercial Property Cycle," RBA Annual Conference Volume, in: Alexandra Heath & Frank Packer & Callan Windsor (ed.), Property Markets and Financial Stability Reserve Bank of Australia.
    8. Sven-Olov Daunfeldt & Matilda Orth & Niklas Rudholm, 2010. "Opening Local Retail Food Stores: A Real-Options Approach," Journal of Industry, Competition and Trade, Springer, Springer, vol. 10(3), pages 373-387, September.
    9. Driessen, Joost & Van Hemert, Otto, 2012. "Pricing of commercial real estate securities during the 2007–2009 financial crisis," Journal of Financial Economics, Elsevier, Elsevier, vol. 105(1), pages 37-61.
    10. Steven H. Ott & Timothy J. Riddiough & Ha-Chin Yi, 2008. "On Demand: Cross-Country Evidence From Commercial Real Estate Asset Markets," International Real Estate Review, Asian Real Estate Society, Asian Real Estate Society, vol. 11(1), pages 1-37.
    11. Andrianos Tsekrekos & George Kanoutos, 2013. "Real Options Premia Implied from Recent Transactions in the Greek Real Estate Market," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 47(1), pages 152-168, July.
    12. Cutter, W. Bowman & Franco, Sofia F., 2012. "Do parking requirements significantly increase the area dedicated to parking? A test of the effect of parking requirements values in Los Angeles County," Transportation Research Part A: Policy and Practice, Elsevier, vol. 46(6), pages 901-925.
    13. Robert Grovenstein & James Kau & Henry Munneke, 2011. "Development Value: A Real Options Approach Using Empirical Data," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 43(3), pages 321-335, October.
    14. Jeffrey Stokes, 2012. "The value of the option to preserve farm real estate," Journal of Economics and Finance, Springer, Springer, vol. 36(1), pages 162-175, January.
    15. Belal Fallah & Mark Partridge & M. Olfert, 2012. "Uncertain economic growth and sprawl: evidence from a stochastic growth approach," The Annals of Regional Science, Springer, Springer, vol. 49(3), pages 589-617, December.
    16. Abdullah Yavas & C. Sirmans, 2005. "Real Options: Experimental Evidence," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 31(1), pages 27-52, August.
    17. Pattikawa, L.H., 2006. "Modeling Brand Extension as a Real Option: How Expectation, Competition and Financial Constraints Drive the Timing of Extensions," ERIM Report Series Research in Management, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasm ERS-2006-030-STR, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    18. Robert Fourt & Gianluca Marcato & Charles Ward, 2007. "Real Option Pricing in Mixed-use Development Projects," Real Estate & Planning Working Papers, Henley Business School, Reading University rep-wp2007-09, Henley Business School, Reading University.
    19. John Clapp & Katsiaryna Bardos & Tingyu Zhou, 2014. "Expansions and Contractions of Major US Shopping Centers," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 48(1), pages 16-56, January.
    20. Jan Hendrik, Fisch, 2011. "Real call options to enlarge foreign subsidiaries - The moderating effect of irreversibility on the influence of economic volatility and political instability on subsequent FDI," Journal of World Business, Elsevier, vol. 46(4), pages 517-526, October.
    21. Xie, Feixue, 2009. "Managerial flexibility, uncertainty, and corporate investment: The real options effect," International Review of Economics & Finance, Elsevier, Elsevier, vol. 18(4), pages 643-655, October.
    22. Bulan, Laarni T., 2005. "Real options, irreversible investment and firm uncertainty: New evidence from U.S. firms," Review of Financial Economics, Elsevier, Elsevier, vol. 14(3-4), pages 255-279.
    23. Cunningham, Christopher R., 2006. "House price uncertainty, timing of development, and vacant land prices: Evidence for real options in Seattle," Journal of Urban Economics, Elsevier, vol. 59(1), pages 1-31, January.

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