Estimating unobservable valuation parameters for illiquid assets

A problem that often arises in applied finance is one where decision-makers need to choose a value for some parameter that will affect the cash flows between two parties involved in the operation of an illiquid asset. Because the values of the cash flows also depend on various unobservable parameters, identifying the value of the policy parameter that achieves the desired allocation between the parties is no simple task, often resulting in disputes and the invocation of ad hoc approaches. We show how this problem can be solved using an extension of the well-known 'implied volatility' technique from option pricing, and apply it to the determination of equilibrium rental rates on ground leases of commercial land. Copyright (c) The Authors. Journal compilation (c) 2009 AFAANZ.