Uncertainty, Competition and Timing of Land Development: Theory and Empirical Evidence from Hangzhou, China

Abstract

Considering the existence of strong policy intervention in China, this paper introduces policy uncertainty into standard Real Options framework, and provides a theoretical explanation for the land development decision in an emerging market. Based on survival analysis, we examine the determinants of timing of land development empirically, using a sample of 783 residential projects in Hangzhou, China from 2005 to 2011. We use monetary policy indices as measurement of policy environment, and results verify our theoretical prediction that when the expected policy is positive, an increase in policy uncertainty significantly lowers the likelihood of land development; otherwise, policy uncertainty accelerates land development. However, market uncertainty fails to meet the prediction of standard Real Options, which indicates that developers in China focus more on policy uncertainty rather than market uncertainty in exercising their real options. We further find that in the face of declining demand, price volatility significantly accelerates land development, which verifies Grenadier, The Journal of Finance, 51(5), 1653–1679, (1996)’s prediction of “Recession-induced Construction Booms”. Empirical finding also verify that competition alone exerts a negative effect on development timing and also has a positive crossing effect with policy uncertainty.