Sequential American Exchange Property Options
Posted: 18 Aug 2006
Abstract
Property development activities often occur in stages, which are appropriately modeled as sequential American exchange property options, where there are interim expenditures required in order to keep the property development options alive. Normally American exchange options require a numerical solution, but herein there is a new closed-form approximate solution, which is computationally efficient and accurate. This method combines repeats of Margrabe European exchange and Geske compound option solutions with tight upper boundaries of either American perpetuities or European exchange options with a high volatility. Illustrations are provided of the sensitivity of the real sequential options and optimal timing to changes in several parameters, which provide a framework for property policy (tax, subsidy and regulatory) guidelines and for property development strategy evaluation. There are several plausible applications of these real option models in commercial and residential property development, within commercial property leases, with regard to switching tenants, and agricultural alternatives.
Keywords: real property compound exchange options, American sequential investments, tight upper boundaries
Suggested Citation: Suggested Citation