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Hedged Real Estate Portfolios and the Wealth Redistribution Effect of Real Estate Option

Departement d'administration et d'économique, Université du Québec à Trois-Rivières

The realization that risky assets can be replicated by some combination of the asset, riskless bonds and put and call options has motivated the application of option pricing theory to the valuation of real estate assets. Conceptual and empirical problems arising from the unique nature of real estate may necessitate the development of new models different from the Black Scholes formulation currently used in many studies. The Binominal Option Pricing (BOP) model may be more practical in real estate markets for which objective price data is not available: not only is it easier to estimate but it is not critically dependent on an accurate estimate of the instantaneous price variance. The option pricing framework provides an unexpected insight into the redistribution of wealth which can occur as a result of the financial policies pursued by the owner of a levered real estate investment.

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