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the demand of irrational investors. The chief impediment of the arbitrage strategy of buying parents and shorting subsidiaries is short sale constraints.

The value of a short sale opportunity for an index that reflects a broad property portfolio is hardly directly comparable to the short sale cost of a particular stock. In sum, the level of typical lending fees is clearly below the obtained boundary value of shorting costs k3 = 11.86% but some special cases can reach levels far outside this soft arbitrage free price bound. The relatively high value k3 may reflect the fact that actual property can be overpriced because of some irrational investors unlike derivatives where short selling is possible.


Prices of property derivatives do not result from a simple no-arbitrage argument as the derivatives cannot be perfectly replicated. Transaction costs, transaction time and short sale constraints cause a property spread, a measure for prices in the incomplete real estate market. As these frictions inhibit perfect replication, they define arbitrage free price bounds for the property spread.

In the present paper we set up a framework of arbitrage free price bounds for property derivatives. Furthermore, we empirically assign values to the market frictions which affect prices of property deriva- tives or, equivalently, the property spread. We base our research on the UK housing market, where prices for property derivatives are readily available. In particular, we find boundary values of 5.15% for the buyer’s transaction costs, 4.11% for the seller’s transaction costs, 4.46% for transaction time and 11.83% for the short-sale constraint.

These market implied friction costs turn out to be consistent with other research and market obser- vations, and confirm the accuracy of our framework. The price process within the price bounds is left for future research.


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