Depreciation, Building Age, and Market Price Statistics for Reference in Urban Redevelopment Option Pricing

Abstract

This study aims to develop a new option pricing model within a two-phase real option framework to adjust underestimation due to depreciation in urban redevelopment projects (approximately 70% bias in a 10-year Urban Renewal Authority standard redevelopment in Hong Kong). The model is applicable to residential buildings owned by multiple residents. This discrete-time model introduces two novel features, namely, constant depreciation rate and annual increase of average building age. Option values are sensitive to the embedded assumption of annual depreciation effect in the market price statistics for reference (market indices or average prices), which facilitates good decision making for redevelopment.