ABSTRACT： For real estate markets, especially emerging economies with a specific system, it is essential to focus on the reasonableness of the theoretical hypothesis underpinning the real option pricing model, prior to considering application in valuation and investment.

In this paper, we focus on this first-step issue in the context of the Land Finance System in China. Compared with the classic hypothesis, for which the underlying housing price is exogenous to the value of the to-be-developed vacant land, the Land Finance System in China impairs this exogeneity to some extent by the interaction between land value and housing market price.

Considering such relationships, we expand the classic option pricing model into a succinct equilibrium model where both the land value and the housing market price are determined simultaneously. The effect of the Land Finance System is reflected as a parameter β, similar to the parameter ω that reflects the housing market volatility.

Numerical analysis is conducted to investigate the nature of the effect of the system parameter β and the market parameter ω on the variations of both the expected land value and housing market price. Finally, conclusions are drawn concerning an explanation of the housing boom in terms of a system effect.

Keywords: real option, land valuation, housing market, Land Finance System, China

Download