OPTIMAL DEVELOPMENT TIMING OPTIONS IN A FUZZY FRAMEWORK

Abstract

With more and more research being done in the area of real options, the fundamental differences between real estate markets and financial markets must be addressed. Investment in these two markets, ceteris paribus, essentially hinges on optimal timing and pricing. However, recognizing that estimating and predicting market trends are extremely difficult tasks due to the uncertainty in almost every aspect of the market, fuzzy logic becomes a novel way of embracing uncertainty as well as representing such uncertainty mathematically for analysis. Using fuzzy logic, the Black-Scholes financial options pricing model will be modified so as to reflect better the real estate market risk by incorporating the fuzzy concept of uncertainty. The resulting model, when applied to value real options, is found to exhibit the same characteristics of the Black-Scholes model, albeit with an increased sensitivity to the maturity period, and an option value that reflects the lower boundary for real options. In order to facilitate the application of the proposed model for day-to-day evaluation of optimal timing for development options, a template is provided as well.