A risk‐based option pricing strategy for property valuation: an empirical study in Hong Kong

Purpose – The purpose of this paper is to apply a risk‐based option‐pricing framework for property developers to come up with the critical investment timings, based on their tolerance of risk. Design/methodology/approach – The viability of a project is subject to the potential benefit and market conditions. Option embedded in the project is considered a perpetual call option that is an opportunity to establish a new building on a vacant land. With the aid of scenario testing, whether the immediate implementation is appropriate or not can be examined, and which key factor(s) affects the profit most can be assessed. Findings – The results reveal that the chosen study case, Chelsea Court project, is highly favorable from a financial standpoint. Research limitations/implications – Since the Samuelson‐McKean model specializes on non‐expired options that in general fit to the evaluation of options of a land development project with no maturity, it may be limited in evaluating projects with multi‐phases and a maturity date. Practical implications – This valuation framework allows flexibility to assess the plausible investment timing under various suspicious circumstances about the property market. Originality/value – The valuation framework presented in this paper provides advice for prospective property developers on whether to invest now or at a later stage to yield the best return.