The persistence of real estate cycles

This paper presents a model that attempts to explain the underlying causes of the prolonged cycles observed in real estate markets. In addition, the paper characterizes the features that make some property types more prone to such boom-and-bust behavior. The combination of demand uncertainty, adjustment costs, and construction lags leads to two phenomena that may help explain market persistence. The first phenomenon is the reluctance of owners to adjust occupancy levels, even in the face of large shifts in renter demand. The second phenomenon is the occurrence of periods of sustained overbuilding: the addition of new supply in the face of already high vacancy rates.     

Investment under uncertainty and time-inconsistent preferences

While standard real options models assume that agents possess a constant rate of time preference, there is substantial evidence that agents are impatient about choices in the short term but are patient when choosing between long-term alternatives. We extend the real options framework to model the investment-timing decisions of entrepreneurs with time-inconsistent preferences. The impact on investment-timing depends on such factors as whether entrepreneurs are sophisticated or naive in their expectations regarding their future time-inconsistent behavior, and whether the payoff from investment occurs all at once or over time. The model is extended to the case of a competitive equilibrium.     

Information revelation through option exercise

In many real-world situations, agents must formulate optionexercise strategies with imperfect information. In such a setting,agents may infer the private signals of other agents throughtheir observed exercise strategies. The building of an officebuilding, the drilling of an exploratory oil well, and the commitmentof a pharmaceutical company toward the research of a new drugall convey private information to other market participants.This article develops an equilibrium framework for option exercisegames with asymmetric private information. Many interestingaspects of the patterns of equilibrium exercise are analyzed.In particular, informational cascades, where agents ignore theirprivate information and jump on the exercise bandwagon, mayarise endogenously.     

OPTION EXERCISE GAMES: THE INTERSECTION OF REAL OPTIONS AND GAME THEORY

While the real options approach has proven useful in providing an analytical framework for analyzing the timing of investment decisions, a notable failure of the approach has been an almost complete lack of strategic considerations. In standard real options models, invest-ment (and exercise) strategies are for-mulated in isolation, without considering the potential impact of other firms' exercise strategies. This paper illustrates how the intersection of real options and game theory provides powerful new insights into the behavior of economic agents under uncertainty.
Introducing strategic considerations into the real options framework can lead to a rethinking of standard real option analysis. For example, one of-ten cited conclusion of the real options literature is the overturning of the standard capital budgeting rule of in-vesting immediately in any project with a positive NPV. Because the fu-ture value of the asset is uncertain, there may be significant benefits to deferring the investment until condi-tions prove even more favorable. But this result clearly depends on the lack of competitive access to the project. If firms fear preemption, then the option to wait becomes less valuable. For example, while the standard real op-tions models suggest that a real estate developer should wait until the devel-opment option is considerably "in the money," competition and the fear of preemption will likely force develop-ers to build much earlier.     

Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms

Under the standard real options approach to investment underuncertainty, agents formulate optimal exercise strategies inisolation and ignore competitive interactions. However, in manyreal-world asset markets, exercise strategies cannot be determinedseparately, but must be formed as part of a strategic equilibrium.This article provides a tractable approach for deriving equilibriuminvestment strategies in a continuous-time Cournot–Nashframework. The impact of competition on exercise strategiesis dramatic. For example, while standard real options modelsemphasize that a valuable "option to wait" leads firms to investonly at large positive net present values, the impact of competitiondrastically erodes the value of the option to wait and leadsto investment at very near the zero net present value threshold.     

Stock and bond returns with Moody Investors

We present a tractable, linear model for the simultaneous pricing of stock and bond returns that incorporates stochastic risk aversion. In this model, analytic solutions for endogenous stock and bond prices and returns are readily calculated. After estimating the parameters of the model by the general method of moments, we investigate a series of classic puzzles of the empirical asset pricing literature. In particular, our model is shown to jointly accommodate the mean and volatility of equity and long term bond risk premia as well as salient features of the nominal short rate, the dividend yield, and the term spread. Also, the model matches the evidence for predictability of excess stock and bond returns. However, the stock–bond return correlation implied by the model is somewhat higher than that in the data.