Arbitrage Free Price Bounds for Property Derivatives

Juerg M. Syz and Paolo Vanini

Online First™, 23 November 2009

Abstract

Market frictions inhibit the perfect replication of property derivatives, and define the property spread as a price measure in the incomplete real estate market. We identify transaction costs, transaction time, and short sale constraints as the main frictions in this market. Based on these frictions, we set up a framework of arbitrage free price bounds for property derivatives. In turn, we use observed derivative prices to determine the implied cost of the frictions. Lastly, we verify these values by using other research, which confirms the accuracy of our framework.Keywords  Property derivatives – Property spread – Arbitrage free price bounds – Market frictions – Halifax House Price Index

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