The pricing of embedded lease contracts options

Charles-Olivier Amédée-Manesme, Francois Des Rosiers and Philippe Grégoire

ERES from European Real Estate Society (ERES)

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.

JEL-codes: R3 (search for similar items in EconPapers)
Date: 2015-07-01
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