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

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  • Laarni Bulan
  • Christopher J. Mayer
  • C. Tsuriel Somerville

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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Publication status: published as Bulan, Laarni & Mayer, Christopher & Somerville, C. Tsuriel, 2009. "Irreversible investment, real options, and competition: Evidence from real estate development," Journal of Urban Economics, Elsevier, vol. 65(3), pages 237-251, May.
Handle: RePEc:nbr:nberwo:12486

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Cited by:
  1. John Clapp & Piet Eichholtz & Thies Lindenthal, 2012. "Real Option Value over a Housing Market Cycle: West Berlin," ERSA conference papers ersa12p264, European Regional Science Association.
  2. Clapp, John M. & Bardos, Katsiaryna Salavei & Wong, S.K., 2012. "Empirical estimation of the option premium for residential redevelopment," Regional Science and Urban Economics, Elsevier, Elsevier, vol. 42(1-2), pages 240-256.
  3. Robert Grovenstein & James Kau & Henry Munneke, 2011. "Development Value: A Real Options Approach Using Empirical Data," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 43(3), pages 321-335, October.
  4. Andrianos Tsekrekos & George Kanoutos, 2013. "Real Options Premia Implied from Recent Transactions in the Greek Real Estate Market," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 47(1), pages 152-168, July.
  5. John Clapp & Katsiaryna Bardos & Tingyu Zhou, 2014. "Expansions and Contractions of Major US Shopping Centers," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 48(1), pages 16-56, January.
  6. Bontempi, Maria Elena & Golinelli, Roberto & Parigi, Giuseppe, 2010. "Why demand uncertainty curbs investment: Evidence from a panel of Italian manufacturing firms," Journal of Macroeconomics, Elsevier, Elsevier, vol. 32(1), pages 218-238, March.
  7. Maria Cecilia Bustamante, 2011. "Strategic investment, industry concentration and the cross section of returns," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 37454, London School of Economics and Political Science, LSE Library.
  8. Wrenn, Douglas H. & Sam, Abdoul G. & Irwin, Elena G., 2012. "Searching for the Urban Fringe: Exploring Spatio-Temporal Variations in the Effect of Distance versus Local Interactions on Residential Land Conversion Using a Conditionally-Parametric Discrete-Time D," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington, Agricultural and Applied Economics Association 125007, Agricultural and Applied Economics Association.
  9. M. Cecilia Bustamante & Andrés Donangelo, 2014. "Product Market Competition and Industry Returns," FMG Discussion Papers, Financial Markets Group dp728, Financial Markets Group.
  10. Maria Cecillia Bustamante, 2011. "Strategic Investment, Industry Concentration and the Cross Section of Returns," FMG Discussion Papers, Financial Markets Group dp681, Financial Markets Group.
  11. Timothy Dunne & Xiaoyi Mu, 2008. "Investment spikes and uncertainty in the petroleum refining industry," Working Paper 0805, Federal Reserve Bank of Cleveland.
  12. W. Hughen & Dustin Read, 2014. "Inclusionary Housing Policies, Stigma Effects and Strategic Production Decisions," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 48(4), pages 589-610, May.
  13. Sven-Olov Daunfeldt & Matilda Orth & Niklas Rudholm, 2010. "Opening Local Retail Food Stores: A Real-Options Approach," Journal of Industry, Competition and Trade, Springer, Springer, vol. 10(3), pages 373-387, September.
  14. Maria Ibanez & Anthony Pennington-Cross, 2013. "Commercial Property Rent Dynamics in U.S. Metropolitan Areas: An Examination of Office, Industrial, Flex and Retail Space," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 46(2), pages 232-259, February.
  15. Steven Ott & W. Hughen & Dustin Read, 2012. "Optimal Phasing and Inventory Decisions for Large-Scale Residential Development Projects," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 45(4), pages 888-918, November.
  16. William Miles, 2009. "Irreversibility, Uncertainty and Housing Investment," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 38(2), pages 173-182, February.
  17. Jeffrey Stokes, 2012. "The value of the option to preserve farm real estate," Journal of Economics and Finance, Springer, Springer, vol. 36(1), pages 162-175, January.
  18. Sangcheol Song, 2014. "Entry mode irreversibility, host market uncertainty, and foreign subsidiary exits," Asia Pacific Journal of Management, Springer, Springer, vol. 31(2), pages 455-471, June.
  19. Carlos Pestana Barros & Zhongfei Chen & Luis A. Gil-Alana, 2012. "Housing sales in urban Beijing," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 44(34), pages 4495-4504, December.
  20. William Hedberg & John Krainer, 2012. "Housing supply and foreclosures," Working Paper Series, Federal Reserve Bank of San Francisco 2012-20, Federal Reserve Bank of San Francisco.
  21. Clapp, John M. & Salavei, Katsiaryna, 2010. "Hedonic pricing with redevelopment options: A new approach to estimating depreciation effects," Journal of Urban Economics, Elsevier, vol. 67(3), pages 362-377, May.
  22. Kuhnen, Camelia M. & Oyer, Paul, 2012. "Exploration for human capital: Theory and evidence from the MBA labor market," MPRA Paper 39411, University Library of Munich, Germany.

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