The Pricing of Embedded Options in Real Estate Lease Contracts
Leases and rental agreements often have options attached or embedded in them. These options sometimes depend on a number of economic variables such as the consumer price index (CPI), a real estate index and/or the value of real estate underlying the agreement. The evaluation of these options often involves the solution or approximation to a partial differential equation (PDE). This study analyzes the appropriate PDEs which model the situation where the lessee is granted an option to either purchase the property or to renew the lease at a price (rent) indexed to the CPI or some other readily measured economic variable. The PDEs that result from the usual contingent claim asset-pricing framework are derived and numerically solved using the finite difference method with absorbing boundaries. The value of an embedded option to renew a five year lease on class A office space in each of the ternty-five markets for which the National Real Estate Index reports quarterly rental data is estimated. An evaluation of the modelâ€™s "Greeks" confirm that the model conforms to financial intuition which provides support for the accuracy of the estimates.
Volume (Year): 15 (1998)
Issue (Month): 3 ()
|Contact details of provider:|| Postal: American Real Estate Society Clemson University School of Business & Behavioral Science Department of Finance 401 Sirrine Hall Clemson, SC 29634-1323|
Web page: http://www.aresnet.org/
|Order Information:|| Postal: Diane Quarles American Real Estate Society Manager of Member Services Clemson University Box 341323 Clemson, SC 29634-1323|
Web: http://pages.jh.edu/jrer/about/get.htm Email:
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.:
- Stulz, ReneM., 1982. "Options on the minimum or the maximum of two risky assets : Analysis and applications," Journal of Financial Economics, Elsevier, vol. 10(2), pages 161-185, July.
- John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005.
"A Theory Of The Term Structure Of Interest Rates,"
World Scientific Book Chapters,in: Theory Of Valuation, chapter 5, pages 129-164
World Scientific Publishing Co. Pte. Ltd..
- Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
- Hull, John & White, Alan, 1990. "Valuing Derivative Securities Using the Explicit Finite Difference Method," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(01), pages 87-100, March.
- Joseph D. Albert & Willard McIntosh, 1989. "Identifying Risk-Adjusted Indifference Rents for Alternative Operating Leases," Journal of Real Estate Research, American Real Estate Society, vol. 4(3), pages 81-94.
- Geske, Robert & Shastri, Kuldeep, 1985. "Valuation by Approximation: A Comparison of Alternative Option Valuation Techniques," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(01), pages 45-71, March.
- Courtadon, Georges, 1982. "A More Accurate Finite Difference Approximation for the Valuation of Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(05), pages 697-703, December.
- Brennan, Michael J & Schwartz, Eduardo S, 1977. "The Valuation of American Put Options," Journal of Finance, American Finance Association, vol. 32(2), pages 449-462, May.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:jre:issued:v:15:n:3:1998:p:253-266. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (JRER Graduate Assistant/Webmaster)
If references are entirely missing, you can add them using this form.