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The Economic Research Institute, Stockholm School of Economics SSE/EFI Working Paper Series in Economics and Finance

No 492:
A Note on the Pricing of Real Estate Index Linked Swaps

Tomas Björk () and Eric Clapham ()

Abstract: In this paper we discuss the pricing of commercial real estate index linked swaps (CREILS). This particular pricing problem has been studied by Buttimer et al. (1997) in a previous paper.

We show that their results are only approximately correct and that the true theoretical price of the swap is in fact equal to zero. This result is shown to hold regardless of the specific model chosen for the index process, the dividend process, and the interest rate term structure. We provide an intuitive economic argument as well as a full mathematical proof of our result.

In particular we show that the nonzero result in the previous paper is due to two specific numerical approximations introduced in that paper, and we discuss these approximation errors from a theoretical as well as from a numerical point of view.

Keywords: Real estate; index linked swaps; arbitrage; (follow links to similar papers)

JEL-Codes: G13; G20; L85; (follow links to similar papers)

14 pages, February 13, 2002

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