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Irreversible Investment, Real Options, and Competition: Evidence from Real Estate Development

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

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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 1,214 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12486.

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Date of creation: Aug 2006
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Handle: RePEc:nbr:nberwo:12486

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Find related papers by JEL classification:
D4 - Microeconomics - - Market Structure and Pricing
D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
E23 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Production
R3 - Urban, Rural, and Regional Economics - - Production Analysis and Firm Location

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