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Housing Quality in the Forward Contracts Market

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Author Info

  • K. Chau

    ()

  • S. Wong
  • C. Yiu
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    Abstract

    Developers often conduct forward sales (or presales) before building completion to relieve financial risk and burden. However, there are worries that housing units sold in this way will turn out to be substandard because developers, who have been paid for the unfinished units, may have incentives to cut costs by lowering the quality. This is a typical moral hazard problem. Nonetheless, forward sales have been very popular in some Asian cities such as Hong Kong, Singapore, and Taiwan. A plausible explanation is that the market has efficiently adjusted the forward price for this potential quality problem according to developers’ reputations. This paper aims to theoretically explain and empirically test (1) whether reputation is reflected in forward prices and (2) whether the expected quality level matches with the actual quality level. Using the forward and spot sales data of the Hong Kong real estate market, we found that even though housing quality was not observable during presales, the market was able to capitalize developers’ reputations into forward prices accurately. This suggests that the optimal strategy for developers is to stick to the quality level implied by their reputations. Copyright Springer Science+Business Media, LLC 2007

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    File URL: http://hdl.handle.net/10.1007/s11146-007-9018-x
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    Bibliographic Info

    Article provided by Springer in its journal The Journal of Real Estate Finance and Economics.

    Volume (Year): 34 (2007)
    Issue (Month): 3 (April)
    Pages: 313-325

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    Handle: RePEc:kap:jrefec:v:34:y:2007:i:3:p:313-325

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    Web page: http://www.springerlink.com/link.asp?id=102945

    Related research

    Keywords: Real estate forward sales; Moral hazard; Reputation; Market efficiency;

    References

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    1. Mirrlees, J A, 1999. "The Theory of Moral Hazard and Unobservable Behaviour: Part I," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 3-21, January.
    2. Rose Neng Lai & Ko Wang & Yuqing Zhou, 2004. "Sale before Completion of Development: Pricing and Strategy," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 32(2), pages 329-357, 06.
    3. Steve Tadelis, 1997. "What's in a Name? Reputation as a Tradeable Asset," Working Papers 97033, Stanford University, Department of Economics.
    4. Miller, Robert A, 1988. "Innovation and Reputation," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 741-65, August.
    5. David Kreps & Robert Wilson, 1999. "Reputation and Imperfect Information," Levine's Working Paper Archive 238, David K. Levine.
    6. Shapiro, Carl, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 659-79, November.
    7. S. Wong & C. Yiu & M. Tse & K. Chau, 2006. "Do the Forward Sales of Real Estate Stabilize Spot Prices?," The Journal of Real Estate Finance and Economics, Springer, vol. 32(3), pages 289-304, May.
    8. Mueller, Dennis C & Supina, Dylan, 2002. " Goodwill Capital," Small Business Economics, Springer, vol. 19(3), pages 233-53, November.
    9. Garbade, Kenneth D & Silber, William L, 1983. "Price Movements and Price Discovery in Futures and Cash Markets," The Review of Economics and Statistics, MIT Press, vol. 65(2), pages 289-97, May.
    10. Nelson, Phillip, 1970. "Information and Consumer Behavior," Journal of Political Economy, University of Chicago Press, vol. 78(2), pages 311-29, March-Apr.
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    Cited by:
    1. Zheng, Siqi & Wu, Jing & Kahn, Matthew E. & Deng, Yongheng, 2012. "The nascent market for “green” real estate in Beijing," European Economic Review, Elsevier, vol. 56(5), pages 974-984.
    2. C. Yiu & S. Wong & K. Chau, 2009. "Transaction Volume and Price Dispersion in the Presale and Spot Real Estate Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 38(3), pages 241-253, April.
    3. Gang-Zhi Fan & Ming Pu & Seow Ong, 2012. "Optimal Portfolio Choices, House Risk Hedging and the Pricing of Forward House Transactions," The Journal of Real Estate Finance and Economics, Springer, vol. 45(1), pages 3-29, June.
    4. Yongheng Deng & Peng Liu, 2009. "Mortgage Prepayment and Default Behavior with Embedded Forward Contract Risks in China’s Housing Market," The Journal of Real Estate Finance and Economics, Springer, vol. 38(3), pages 214-240, April.
    5. Sherry Zhefang ZHOU & Helen Xiaohui BAO, 2009. "Modelling Price Dynamics In The Hong Kong Property Market," Theoretical and Empirical Researches in Urban Management, Research Centre in Public Administration and Public Services, Bucharest, Romania, vol. 4(1S), pages 8-26, April.

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