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Time to build options in construction processes

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Author Info
Tien Foo Sing
Abstract

Time to build is a very important factor in a real estate development venture. Delay in completion of a project not only affects the financing costs and the rental revenue but also it may, on a more strategic note, determine the success or failure of a project. A time to build option model consisting of a stochastic rate of completion and a stochastic net project payoff is applied to the sequential construction process of a large scale construction project. The results of the sensitivity analysis show that the optimal payoff value, that triggers the exercise of the option to invest at a maximum rate, increases positively with the increases in cash flow volatility, input cost uncertainty, excess asset return per unit risk and maximum rate of investment. However, it has a negative relationship with the rental yield. In a case study involving a commercial project, the premium for hedging the payoff risks by pre-leasing a project was estimated at 11.29%, whereas the additional cost incurred for shielding a project against input cost risks in a design and build contract was estimated at 7.80%, where each is given as a percentage of the total construction costs.

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Publisher Info
Article provided by Taylor and Francis Journals in its journal Construction Management & Economics.

Volume (Year): 20 (2002)
Issue (Month): 2 (March)
Pages: 119-130
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Handle: RePEc:taf:conmgt:v:20:y:2002:i:2:p:119-130

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Related research
Keywords: Time To Build Option; Project Payoff Uncertainty; Input Cost Uncertainty; Sequential Investment; Option Premium;

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References listed on IDEAS
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. Grenadier, Steven R, 1995. "The Persistence of Real Estate Cycles," The Journal of Real Estate Finance and Economics, Springer, vol. 10(2), pages 95-119, March.
  2. Roberts, Kevin & Weitzman, Martin L, 1981. "Funding Criteria for Research, Development, and Exploration Projects," Econometrica, Econometric Society, vol. 49(5), pages 1261-88, September. [Downloadable!] (restricted)
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  3. Williams, Joseph T, 1991. "Real Estate Development as an Option," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 191-208, June.
  4. Pindyck, Robert S., 1993. "Investments of uncertain cost," Journal of Financial Economics, Elsevier, vol. 34(1), pages 53-76, August. [Downloadable!] (restricted)
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  5. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November. [Downloadable!] (restricted)
  6. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March. [Downloadable!] (restricted)
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  7. Titman, Sheridan, 1985. "Urban Land Prices under Uncertainty," American Economic Review, American Economic Association, vol. 75(3), pages 505-14, June. [Downloadable!] (restricted)
  8. Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1992. "Waiting to Invest: Investment and Uncertainty," Journal of Business, University of Chicago Press, vol. 65(1), pages 1-29, January. [Downloadable!] (restricted)
  9. Quigg, Laura, 1993. " Empirical Testing of Real Option-Pricing Models," Journal of Finance, American Finance Association, vol. 48(2), pages 621-40, June. [Downloadable!] (restricted)
  10. Gene M. Grossman & Carl Shapiro, 1986. "Optimal Dynamic R&D Programs," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 581-593, Winter. [Downloadable!] (restricted)
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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. Yu-Lin Huang & Shih-Pei Chou, 2006. "Valuation of the minimum revenue guarantee and the option to abandon in BOT infrastructure projects," Construction Management & Economics, Taylor and Francis Journals, vol. 24(4), pages 379-389, April. [Downloadable!] (restricted)
  2. C. Y. Yiu & C. S. Tam, 2006. "Rational under-pricing in bidding strategy: a real options model," Construction Management & Economics, Taylor and Francis Journals, vol. 24(5), pages 475-484, May. [Downloadable!] (restricted)
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