CAN HYSTERESIS AND REAL OPTIONS EXPLAIN THE FARMLAND VALUATION PUZZLE?

This paper proposes that the common finding that land prices are systematically higher than their fundamental value as measured by the present value of future cash might be due to real options arising from uncertainty in cash flows. The paper posits a model in which the seller has a real option to postpone the sale of land. Because the value of land is measured as a present value, the buyer does not hold a similar option to postpone the purchase. It is argued that the seller's option offers a plausible explanation for the wedge between observed farmland prices and the present value model. The paper uses a Dixit and Pindyck (1996) real options framework. Using historical cash flow and land price information for Ontario, it is shown how real options can lead to a land price greater than that predicted by the present value model. The findings also suggest the existence of land price bubbles and shows how a real options framework can be used to detect bubbles.


Issue Date:
2002
Publication Type:
Working or Discussion Paper
PURL Identifier:
http://purl.umn.edu/34131
Total Pages:
33
Series Statement:
Working Paper 02/11




 Record created 2017-04-01, last modified 2017-08-25

Fulltext:
Download fulltext
PDF

Rate this document:

Rate this document:
1
2
3
 
(Not yet reviewed)