Abstract
The aim of this paper is to propose a real options framework to measure and manage bubbles in the Korean real estate market. The proposed framework carefully defines and utilizes the unique leasing mechanism in Korea, called the Jeonse system, a tentative contract for one or two years with a large amount of deposit, to represent the value of residence. Furthermore, the proposed framework applies the volatility with heteroscedasticity to improve the numerical accuracy in comparison to the traditional real options valuation model. The results of the model ultimately suggest the investment strategy that takes into account the measured bubbles in the market. Specifically, given that the Korean real estate market could be regarded as an American option, the investment strategy with early exercise completely eliminates the existing arbitrage opportunities in both long and short positions. In this context, the investment decisions based on the results of the proposed framework are expected to encourage the reflection of bubble-related information in the market, which eventually reduces the formation of bubbles via market mechanism for arbitrage elimination. In conclusion, the bubble-related information obtained from the model is expected to contribute to the stability of the real estate market by reducing the volatility of house price and quick price adjustment to new information.
Highlights
In recent years, researchers have suggested various empirical evidence of the cause, progress and contagion of the global financial crisis in 2007–2009
We attempt to measure and manage the bubbles as a way to support the sustainability of the Korean real estate market
Our paper is novel in that, to our best knowledge, this is the first attempt to measure the bubbles in the Korean real estate market in the real options framework
Summary
Researchers have suggested various empirical evidence of the cause, progress and contagion of the global financial crisis in 2007–2009. It is a well-known fact that the origin of the crisis was the downfall of the U.S sub-prime mortgage products emanating from the collapse of the bubble in the U.S real estate market. The quantitative easing brought the stability of the U.S economy back, but a similar bubble-related crisis may recur at any time in any country. Developing countries that have experienced a rapid economic growth and expansion of the real estate market should learn the lessons from the U.S sub-prime mortgage crisis.
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