Trading Barriers for Property Derivatives

The recent global financial crisis (2007 – 2009) has shown what cataclysmic consequences the convergence of financial markets and real estate markets can have for the macro economies of entire nations. The interweavement of the two markets provides opportunities for product innovations on the one hand and involves new risks on the other. Investors who are familiar with financial markets, do not necessarily know the peculiarities of real estate markets, and vice versa. The financial crisis has also shown how important it is, to adapt flexible holding strategies and to be able to unwind property investments quickly. Real estate is the last major asset class without liquid derivatives markets. The reasons for that are not fully known and understood. Three aggravating factors are the heterogeneous structure of real estate markets, the difficulties associated with the measurement of financial performance in a timely manner and a certain degree of predictability of real estate prices. The lack of liquid derivatives markets has some repercussions on real estate as an asset class. It is not possible to completely reproduce the financial characteristics of real estate by combining other financial assets. This makes the market incomplete which renders hedging difficult and perfect risk transfer impossible.This paper seeks to find out why are real estate investors reluctant to use property derivatives. The aim of the research is to better understand the factors that determine the acceptance of real estate derivatives and those that keep potential users from applying them. With an in-depth qualitative research the view of potential users towards property derivatives shall be captured and current trading barriers be identified. Ways of overcoming them will be proposed. A better understanding of the investment behaviour and attitudes towards property derivatives will help explain why no liquid markets have been established yet, despite numerous attempts. Reasons for the low trading volumes on the two stock exchanges, the Chicago Mercantile Exchange (CME) in the U.S. and the European Exchange (Eurex) shall be identified. A liquidity enhancing framework for both the OTC and exchange traded property derivative markets will be proposed.