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A reduced-form model for lease contract valuation with embedded options

Author

Listed:
  • Chuang-Chang Chang

    (National Central University)

  • Hsiao-Wei Ho

    (National Taiwan Ocean University)

  • Henry Hongren Huang

    (National Central University)

  • Yildiray Yildirim

    (The City University of New York (CUNY))

Abstract

This paper provides an analytical formula for valuing lease contracts in the most general case, including adjustable leases, with cancellation, purchase, and default options. We then illustrate the numerical implementation of our model. Numerical analysis reveals that the lessor offers a discount on the initial rent for a longer-term lease contract but charges an additional amount for cancelation, purchase, and default risk compared to the contract without any embedded options. This result suggests that ignoring embedded options in valuing a lease contract leads to significant pricing errors. Thus, we provide a framework to value complex lease contracts and enhance real-estate lease portfolio management efficiency.

Suggested Citation

  • Chuang-Chang Chang & Hsiao-Wei Ho & Henry Hongren Huang & Yildiray Yildirim, 2024. "A reduced-form model for lease contract valuation with embedded options," Review of Quantitative Finance and Accounting, Springer, vol. 62(2), pages 841-864, February.
    • Handle: RePEc:kap:rqfnac:v:62:y:2024:i:2:d:10.1007_s11156-023-01222-8
    DOI: 10.1007/s11156-023-01222-8
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    References listed on IDEAS

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    More about this item

    Keywords

    Credit risk; Embedded options; Reduced-form model; Lease rate;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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