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The pricing of embedded lease contracts options

Author

Listed:
  • Charles-Olivier Amédée-Manesme
  • Francois Des Rosiers
  • Philippe Grégoire

Abstract

In all the major asset class, implied volatility is obtained from the quotations of the derivatives market. However, in real estate, derivatives market is almost inexistent and volatility pricing face many difficulties. This paper proposes a methodology to determine implied volatility of real estate market based on options embedded in lease contracts. Leases are generally agreed for long term with possible options to leave in favour of the tenant during the course of the lease. Tenants that have no break-options during the life of their lease expect either to pay a lower rent or to receive more gratuities (rent free, financial incentives...) than those with options to leave. We built up a model that allows estimating implied volatility based on the leasing transactions by analogy between lease options and financial options.

Suggested Citation

  • Charles-Olivier Amédée-Manesme & Francois Des Rosiers & Philippe Grégoire, 2015. "The pricing of embedded lease contracts options," ERES eres2015_57, European Real Estate Society (ERES).
  • Handle: RePEc:arz:wpaper:eres2015_57
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    JEL classification:

    • R3 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location

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