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Strategic Urban Development under Uncertainty

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  • Flavia Cortelezzi
  • Pierpaolo Giannoccolo

Abstract

Aim of this paper is to analyse the equilibrium strategies of two developers in the real estate market, when demands are asymmetric. In particular, we are able to consider three key features of the real estate market. First, the cost of redevelop a building is, at least partially, irreversible. Second, the rent levels for different building vary stochastically over time. Third, demand functions for space are interrelated and may produce positive or negative externalities. Using the method of option pricing theory, we address this issue at three levels. First, we model the investment decision of a firm as a pre-assigned leader as a dynamic stochastic game. Then, we solve for the non-cooperative (decentralised) case, and for the perfectly cooperative case, in which redevelopment of an area is coordinated between firms. Finally, we analyse the efficiency/inefficiency of the equilibria of the game. We find that if one firm has a significantly large comparative advantage, the pre-emptive threat from the rival will be negligible. In this case, short burst and overbuilding phenomena as predicted by Grenadier (1996) will occur only as a limiting case.

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File URL: http://www.statistica.unimib.it/utenti/WorkingPapers/WorkingPapers/20060601.pdf
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Bibliographic Info

Paper provided by Università degli Studi di Milano-Bicocca, Dipartimento di Statistica in its series Working Papers with number 20060601.

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Length: 21 pages
Date of creation: Jun 2006
Date of revision: Jun 2006
Handle: RePEc:mis:wpaper:20060601

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Related research

Keywords: Duopoly Game; Real Options; Preemptive Strategies; Asymmetric Demands;

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References

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  1. 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.
  2. Dennis R. Capozza & Yuming Li, 2001. "Residential Investment and Interest Rates: An Empirical Test of Land Development as a Real Option," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 29(3), pages 503-519.
  3. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
  4. Helen Weeds, 2002. "Strategic Delay in a Real Options Model of R&D Competition," Review of Economic Studies, Oxford University Press, vol. 69(3), pages 729-747.
  5. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
  6. Weeds, H., 1999. "Sleeping Patents and Computsory Licensing: An Options Analysis," The Warwick Economics Research Paper Series (TWERPS) 577, University of Warwick, Department of Economics.
  7. Capozza, Dennis & Li, Yuming, 1994. "The Intensity and Timing of Investment: The Case of Land," American Economic Review, American Economic Association, vol. 84(4), pages 889-904, September.
  8. Quigg, Laura, 1993. " Empirical Testing of Real Option-Pricing Models," Journal of Finance, American Finance Association, vol. 48(2), pages 621-40, June.
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Cited by:
  1. Dominik Weiß, 2009. "Keeping the Bubble Alive! The Effects of Urban Renewal and Demolition Subsidies in the East German Housing Market," IWH Discussion Papers 11, Halle Institute for Economic Research.

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