Designing Property Futures Contracts and Options Based on NCREIF Property Indices

Executive Summary.

Due to the heterogeneous nature of real estate assets, as well as the difficulty in selecting a reliable and representative underlying index, real estate markets are the last of the major asset classes not to have a liquid coming times market. The design presented here for quality futures contracts is based upon a selection of NCREIF quality Indices (NPIs). Seventy-five potential underlying indexes / sub indexes in the NCREIF database are examined. The findings indicate that provided an innovative combination of contract specifications is prefered establishing NPI-based property futures and options is conceptually feasible. They would exhibit a notable improvement to the common situation where risk management tools are notoriously scarce for real estate investors.

Future contracts are among the oldest existing derivatives instruments. They have been actively traded for centuries with the first recorded case of organized coming times trading being certified in Japan in the 1600 Their disentanglement in the western capitalist economies was feeded by the introduction of the financial subsequent times market in 1972 on the Chicago Mercantile Exchange.

Today, time to comes markets cover a wide array of risks including force credit, and weather. However, individual major asset class is conspicuously missing from this list: real estate. Indeed, attribute markets are the last of the major asset classes not to have a liquid time to comes market.

Despite intense interest from the academic community for time to comes and options cash-settled on real estate prices (eg Case, Shiller, and Weiss, 1993) and the novel advent of over-the-counter swaps (Fisher, 2005) participants in real estate markets still have no efficient and cost-effective way to hedge their in all senses to risks. Organized exchanges, wary of real estate's idiosyncrasies and possibly unnerv by dint of the failure of past attempts to launch characteristic futures (e.g., Fox Property futuritys in the United Kingdom in the early 1990s) have seemingly given up upon establishing property futures and options markets.

The overriding argument against the establishment of standardized derivatives upon non-securitized real estate is the lack of reliable indices [i.e., indices that provide a real-time and representative pricing of underlying assets, which are inherently all different (eg Gordon and Havsy, 1999)] As a matter of fact, in what way could an index with les than continuous observations be used as a measure of the change in real estate prices for a continuously traded derivative? in what manner might standardized futures contracts upon private commercial real estate be structur to best suited investors' hedging needs?

This paper answers these questions by the agency of examining real estate index-based futuritys and options in light of existing contracts upon financial and non-financial assets. To do in the way that it contains six main sections organized as come [i]or[/i] go after [i]or[/i] behinds In the first section, it analyzes fundamental conditions determining the succes of a subsequent times contract. In the second section, it reviews the conceptions underlying the design of peculiarity futures contracts based on NCREIF attribute Indices (NPIs). In the third section, it explains the choice of underlying index and unfolds methodologies for selecting the greatest in quantity appropriate sub-indices. In the fourth section, it describes other contract specifications including lagged adjustment procedures, and an innovative template for a peculiarity futures market. In the fifth section, it introduces a series of quality options, as well as hellenic letters for property options traders. In the sixth section, it nears examples illustrating potential uses of peculiarity futures and options before concluding that a first pace towards establishing property futures and options tied to private commercial real estate is conceptually feasible. Legal and regulatory issues potentially affecting derivatives are beyond the end of this paper.

Conditions Determining the Succes of a futuritys Contract

Before getting into the nut and shafts of designing property futures contracts based upon NCREIF Property Indices, it is essential to understand on what account some contracts are successful whereas others fail. Conclusions identified by means of researchers who have worked upon this topic provide useful ball of threads for a successful design of peculiarity futures contracts.

Conditions that determine the succes of a time to comes contract have been extensively analyzed. There are a certain number of important prerequisite conditions such as convolution and liquidity that have to be met in the way that that trading in the contract is profitable for exchanges (Duffie and Rahi, 1995; and owner Tomas, and Webb, 1999). In a nutshell, a prosperous contract is one that maintains a consistently high convolution of trade and open interest (Black, 1986; and Holland and Vila, 1997) A happy contract is also one that is supported, at least in its nascent stage, through the futures exchange listing it (case, Shiller, and Weiss, 1993) Innovative contracts ofttimes have a slow start and a substantial financial commitment is generally straited