Working Paper: NBER ID: w12486
Authors: Laarni Bulan; Christopher Mayer; C. Tsuriel Somerville
Abstract: We examine the extent to which uncertainty delays investment and the effect of competition on this relationship using a sample of 1,214 condominium developments in Vancouver, Canada built from 1979-1998. We find that increases in both idiosyncratic and systematic risk lead developers to delay new real estate investments. Empirically, a one-standard deviation increase in the return volatility reduces the probability of investment by 13 percent, equivalent to a 9 percent decline in real prices. Increases in the number of potential competitors located near a project negate the negative relationship between idiosyncratic risk and development. These results support models in which competition erodes option values and provide clear evidence for the real options framework over alternatives such as simple risk aversion.
Keywords: real options; investment; competition; real estate; uncertainty
JEL Codes: D4; D52; E23; R3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Idiosyncratic return volatility (G17) | Delay in new real estate investments (G31) |
| Systematic return volatility (G17) | Delay in new real estate investments (G31) |
| Competition (L13) | Mitigation of negative impact of idiosyncratic risk on investment timing (G11) |
| Idiosyncratic risk (D81) | Real prices (P22) |