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Irreversible investment, real options, and competition: Evidence from real estate development

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Author Info
Bulan, Laarni
Mayer, Christopher
Somerville, C. Tsuriel

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Abstract

We examine the extent to which uncertainty delays investment, and the effect of competition on this relationship, using a sample of 1214 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.

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Publisher Info
Article provided by Elsevier in its journal Journal of Urban Economics.

Volume (Year): 65 (2009)
Issue (Month): 3 (May)
Pages: 237-251
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Handle: RePEc:eee:juecon:v:65:y:2009:i:3:p:237-251

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Web page: http://www.elsevier.com/locate/inca/622905

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Elena Bontempi & Roberto Golinelli & Giuseppe Parigi, 2007. "Why demand uncertainty curbs investment: Evidence froma a panel of Italian manufacturing firms," Temi di discussione (Economic working papers) 621, Bank of Italy, Economic Research Department. [Downloadable!]
  2. Timothy Dunne & Xiaoyi Mu, 2008. "Investment spikes and uncertainty in the petroleum refining industry," Working Paper 0805, Federal Reserve Bank of Cleveland. [Downloadable!]
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