Pricing the Options in Housing Contracts and Risk Management

Abstract

The recent global financial crisis has hampered economic activities in many ways; however, the impact on the real estate market has been particularly huge. In Korea, falling real estate prices has meant many construction companies going bankrupt because of the vast number of unsold apartments. To alleviate this problem, construction companies have begun to provide potential apartment buyers with free options such as the withdrawal guarantee option, principal guarantee option, premium guarantee option, and buy-back option. In this study, we attempt to analyze the real value and the market risk of these options which has no market value yet. To price the options, we used GARCH option pricing model and Esscher transform. As the result, the price of the withdrawal guarantee option was significantly higher than the other options, and this fact implies that this option may be attractive to the investor in terms of marketing, while the construction firms as issuer may pay the costs. In addition, we applied the DD(Default to Distance) of two companies and VaR of the options in order to manage the risk caused by the options. As the result, according to the analysis of the DD, the issue of the options seems to be helpful to the company immediately. According to the VaR analysis, the principal guarantee option is the most risky option among the options by falling the value of the asset and the value of the option in depressing markets.