Presale Contract and its Embedded Default and Abandonment Options

Presale Contract and its Embedded Default and Abandonment Options The presale contract is a popular property selling method that allows a buyer to default on the remaining payment and/or a developer to abandon a project. Using a simple two-period game theoretical model, we derive a closed-form pricing equation for a presale contract that explicitly accounts for a developer’s abandonment option and a buyer’s default option. Although a developer has an abandonment option under either a spot sale or a presale method, the option is more valuable under a presale contract because of an additional cash inflow from the presale downpayment. A presale also provides a buyer a default option, which is valuable in a real estate market with uncertain demand and price risk. We analyze the implications of the abandonment option on a developer’s construction decision and choice of selling method, as well as the implications of the default option on a buyer’s purchase decision. Furthermore, our model framework has implications to the pricing of futures contracts that involve both stochastic revenues and costs. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Real Estate Finance and Economics Springer Journals

Presale Contract and its Embedded Default and Abandonment Options

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Publisher
Springer US
Copyright
Copyright © 2010 by Springer Science+Business Media, LLC
Subject
Economics; Regional/Spatial Science; Financial Services
ISSN
0895-5638
eISSN
1573-045X
D.O.I.
10.1007/s11146-010-9289-5
Publisher site
See Article on Publisher Site

Abstract

The presale contract is a popular property selling method that allows a buyer to default on the remaining payment and/or a developer to abandon a project. Using a simple two-period game theoretical model, we derive a closed-form pricing equation for a presale contract that explicitly accounts for a developer’s abandonment option and a buyer’s default option. Although a developer has an abandonment option under either a spot sale or a presale method, the option is more valuable under a presale contract because of an additional cash inflow from the presale downpayment. A presale also provides a buyer a default option, which is valuable in a real estate market with uncertain demand and price risk. We analyze the implications of the abandonment option on a developer’s construction decision and choice of selling method, as well as the implications of the default option on a buyer’s purchase decision. Furthermore, our model framework has implications to the pricing of futures contracts that involve both stochastic revenues and costs.

Journal

The Journal of Real Estate Finance and EconomicsSpringer Journals

Published: Oct 15, 2010

References

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