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Illiquidity, transaction cost, and optimal holding period for real estate: Theory and application

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  • Cheng, Ping
  • Lin, Zhenguo
  • Liu, Yingchun
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    Abstract

    Choosing the optimal holding period is an important part of real estate investment decisions, because "when to sell" affects "whether to buy". This paper presents a theoretical model for such decision making. Our model indicates that the optimal holding period is affected by both systematic and non-systematic factors--market conditions (illiquidity and transaction cost) and property performance (return and return volatility). Other things being equal, higher illiquidity and transaction costs lead to longer holding periods, while higher return volatility implies shorter holding periods. Our empirical application suggests that the optimal holding period based on our model is quite consistent with previous empirical findings. In addition, we find that when illiquidity risk is incorporated the true real estate risk is significantly higher than the conventional risk estimate. Therefore, the current practice of real estate valuation, which is naively borrowed from finance theory, substantially underestimates real estate risk.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Housing Economics.

    Volume (Year): 19 (2010)
    Issue (Month): 2 (June)
    Pages: 109-118

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    Handle: RePEc:eee:jhouse:v:19:y:2010:i:2:p:109-118

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    Web page: http://www.elsevier.com/locate/inca/622881

    Related research

    Keywords: Illiquidity Transaction cost Holding period for real estate Illiquidity risk;

    References

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    Cited by:
    1. Bond, Shaun A. & Chang, Qingqing, 2012. "Liquidity dynamics across public and private markets," Journal of International Money and Finance, Elsevier, vol. 31(7), pages 1890-1910.

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