Real estate index options: Possibility of using for the Polish market

The real estate derivatives market has emerged over more than 20 years. The first early attempt of a property derivative market began in London around 1994. It was connected with the development of reliable property value indexes. However, the market for property derivatives did not catch the interest of investors in that time. Nowadays, more attention is paid to this market. Although many derivative types are available for residential and commercial indices, the most common type of transaction would be in swaps and eventually forward agreements.

The article focuses on the potential use of options for the real estate index. We will present advantages, drawbacks and limitations of using those instruments. There are differences between the real estate index options and other financial options. The real estate market index is the underlying asset in options. Therefore, it should reflect a certain real estate portfolio. However, in contrast to the stock index, it is very difficult to take a position reflecting the real estate index on the market. Moreover, the real estate market is not as liquid as the stock market, not transparent enough, and there is a weak form of efficiency according to which information about the transaction is not immediately reflected in the price of the object. The paper will discuss the specific features of the real estate market.

The price of housing is harder to measure than that of most assets because of three characteristics: dwellings are heterogeneous, no two dwellings are identical (in the same location), sampled housing prices may be a poor indicator of all housing prices because we cannot always reliably predict the sales price of a given dwelling from the price of another (Wood 2005; p. 213).

The main methods suggested in the literature to calculate the housing index are stratification or mix adjustment, repeat sales, hedonic regression, and use of property assessment information. In our research we use the existing stock hedonic housing price indexes - Housing Prices Database of the Narodowy Bank Polski (NBP). These indicators reflect the "pure" price change, thus correct for quality changes (eg, increase or decrease in the share of more expensive housing in the sample).