Beyond Index-Based Hedging: Can Real Estate Trigger a New Breed of Derivatives

As index-based real estate derivatives are being introduced in Europe and the US, this paper questions the validity of these instruments for hedging risks involved in commercial real estate markets. It first examines the concept of index-based derivatives in the broader context of the history of derivatives and shows that this recent concept may not be appropriate for intrinsically heterogeneous assets such as real estate. Based on an innovative framework drawn from the field of biomedical sciences, it then considers several alternatives and concludes by proposing the establishment of a radically new breed of derivatives market that would enable effective hedging of commercial real estate assets.