Property Derivatives: Pricing, Hedging and Applications (The Wiley Finance Series)
Juerg M. Syz | 2008-08-04 00:00:00 | Wiley | 252 | Finance
Property derivatives have the potential to revolutionize real estate - the last major asset class without a liquid derivatives market. The new instruments offer ease and flexibility in the management of property risk and return.
Property funds, insurance companies, pension and life funds, speculators, hedge funds or any asset manager with a view on the real estate market can apply the new derivatives to hedge property risk, to invest synthetically in real estate, or for portfolio optimization. Moreover, developers, builders, home suppliers, occupiers, banks, mortgage lenders and governmental agencies can better cope with their real estate exposure using property derivatives.
This book is a practical introduction to property derivatives and their numerous applications. Providing a comprehensive overview of the property derivatives market and indices, there is also in-depth coverage of pricing, hedging and risk management, which will deepen the readers understanding of the market's mechanisms.
Covering both the theoretical and practical aspects of the property derivatives markets; this book is the definitive reference guide to a new and fast-growing market.
Reviews
The author has prepared an easy-to read overview of the newly emerged market for futures, swaps and options based on a property index. The book describes the activity in these markets in Europe, the United States and Asia, and presents some elementary approaches for valuation and risk management. However, there is insufficient analytical firepower here to address the numerous issues raised when considering property derivatives for real-world portfolio management.
The prerequisites are kept to the bare minumum. A few chapters of Hull's Options, Futures and Other Derivatives (6th Edition) should provide more than adequate preparation for this text by Syz. Elementary probability and statistics are also used, at the level of the undergraduate text Introduction to Mathematical Statistics by Hogg and Craig.
The book is comprised of three parts.
In Part 1, the author outlines some aspects of the real estate market and argues that without property derivatives, access to exposure in real estate is limited (see Section 1.2, page 5). This statement seemingly overlooks the impact of CMOs, CDOs and other financial instruments whose prices are derived from property values. Very little is mentioned in the book about Mortgage-backed Securities, their derivatives, and relationships of these well-established instruments to property vaues. This part of the book does a nice job explaining a few of the complexities in the real-estate market, and describes the various property indices that have been constructed as benchmarks in various markets.
In Part 2, the author presents some basic analytics for the purposes of pricing, hedging and risk management. An attempt is made in Chapter 7 to understand the dynamics of a property price index, but the analysis here is extremely elementary and probably not suitable for the construction of robust valuation models. The sections on risk management give merely an introduction based on simplistic value-at-risk modeling, and while some risk managers might attempt to use these models, it would almost certainly be at considerable risk.
Part 3 offers a handful of possible applications of property derivatives for portfolio management. One of the genuine problems with applying any of these strategies is due to the fact that this property derivatives market, as the auther points out, is incomplete from a mathematical finance perspective. Being unable to replicate, say, a put option on the RPX index inhibits a would-be property derivatives market-maker from selling this put and therefore taking an unhedged long position in property ( a relatively dangerous strategy of late). If it is also the case that real-estate markets, due to lack of liquidity and other idiosyncratic factors, admit arbitrage, then most of the modern theory of arbitrage pricing, including the Black-Scholes model as employed by the author, is not directly applicable for property derivatives.
The book concludes with an appendix which discusses some simple formulas for correlation analysis, convexity adjustments for valuation, and basic delta/gamma hedging with options.
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