Empirical testing of the flexibility value in land auction prices

This paper uses project level data of land auction prices in Hong Kong. It tests the hypotheses that the land auction price (real option premium) contains three sources of flexibility value: waiting to invest, the effect of direct interactions and the effect of financial structure. The OLS regression results show that the option premium embedded in the land price is not only related to real flexibility choices such as delaying investment as identified in traditional real option theory, but it also increases or decreases with the direct interaction of properties, their competition for firm resources and the firmís financial status. Firms with more investment properties located close to the auctioned land and with more internal funds would place a higher value on the land at auction; while more profitable firms and firms with less debt capacity would lower its estimate of option value embedded in the auctioned land prices as reflected in bidding. The interaction effect and financial structure in the firm have been confirmed in the empirical studies to influence the option premium in the land price. These results confirm the link between the project level predictions of real option theory and firm fundamentals.