Housing Quality in the Forward Contracts Market
K. W. Chau
S. K. Wong
C. Y. Yiu
Published online: 13 February 2007
Springer Science + Business Media, LLC 2007
Abstract Developers often conduct forward sales (or presales) before building
completion to relieve financial risk and burden. However, there are worries that
housing units sold in this way will turn out to be substandard because developers,
who have been paid for the unfinished units, may have incentives to cut costs by
lowering the quality. This is a typical moral hazard problem. Nonetheless, forward
sales have been very popular in some Asian cities such as Hong Kong, Singapore,
and Taiwan. A plausible explanation is that the market has efficiently adjusted the
forward price for this potential quality problem according to developers’ reputations.
This paper aims to theoretically explain and empirically test (1) whether reputation is
reflected in forward prices and (2) whether the expected quality level matches with
the actual quality level. Using the forward and spot sales data of the Hong Kong real
estate market, we found that even though housing quality was not observable during
presales, the market was able to capitalize developers’ reputations into forward
prices accurately. This suggests that the optimal strategy for developers is to stick to
the quality level implied by their reputations.
Keywords Real estate forward sales
Futures and forward contracts are commonly traded derivatives in the financial
market and in a number of commodity markets such as sugar, coffee, and wheat.
Their economic functions of hedging and price discovery have been well
J Real Estate Finan Econ (2007) 34:313–325
A paper submitted to Journal of Real Estate Finance and Economics. A Special Issue for the 2005 NUS-
HKU Symposium on Real Estate Research.
K. W. Chau (*)
S. K. Wong
C. Y. Yiu
Department of Real Estate and Construction, The University of Hong Kong, Pokfulam Road,
Hong Kong, China