Working paper

Risk-aversion and urban land development options

17 Mar 2012

The urban land development options literature invariably assumes that developers are risk-averse and that the risks can be perfectly spanned in a complete urban land market are discussed in this working paper series.

The proposed utility based real options model that allows for developers’ risk preferences and incomplete urban land markets shows that developers’ precautionary savings motives have important implications for optimal land development decisions. These results predict that high uncertainty decreases the optimal intensity and threshold of capital investment in urban land. The negative impact of developers’ risk-aversion on the threshold disproves the standard real options prediction that uncertainty inhibits urban growth.
Using empirical data on public land sales by tender in Singapore from 1Q1990 to 1Q2012, we found that developers’ risk aversion has a significant negative impact on the values (option premiums) of development lands. Furthermore, our results showed a significant negative relationship between developers’ risk-aversion and the supply of private residential units under construction. When we separated the supply (pipeline) into low-density (landed) and high-density (non-landed) developments, we found the opposite result in the low-density development lands. Thus, risk-averse developers are more likely to delay low-density development projects in an uncertain market.

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