JMF  Vol.5 No.1 , February 2015
A Real Options Approach to Distressed Property Borrower-Lender Reconciliation
Abstract: We propose a real option framework to value distressed properties and restructure their loans. Our approach reconciles the interests of borrowers and lenders through a constrained optimization model yielding mutually beneficial restructure terms. Borrowers receive lower loan balances and payments, while lenders replace non-performing loans with performing loans that have higher market values. A numerical illustration shows that the market value of a restructured loan can exceed that of the original non-performing loan and the post-foreclosure cash flows when the lender repossesses the property.
Cite this paper: Moore, D. and Ikromov, N. (2015) A Real Options Approach to Distressed Property Borrower-Lender Reconciliation. Journal of Mathematical Finance, 5, 73-81. doi: 10.4236/jmf.2015.51007.

[1]   Titman, S. (1985) Urban Land Prices under Uncertainty. The American Economic Review, 75, 505-514.

[2]   Williams, J.T. (1991) Real Estate Development as an Option. The Journal of Real Estate Finance and Economics, 4, 191-208.

[3]   McConnell, J.J. and Schallheim, J.S. (1983) Valuation of Asset Leasing Contracts. Journal of Financial Economics, 12, 237-261.

[4]   Grenadier, S.R. (1995) Valuing Lease Contracts a Real-Options Approach. Journal of Financial Economics, 38, 297-331.

[5]   Grenadier, S.R. (1996) Leasing and Credit Risk. Journal of Financial Economics, 42, 333-364.

[6]   Kau, J.B., Keenan, D.C., Muller III, W.J. and Epperson, J.F. (1993) Option Theory and Floating-Rate Securities with a Comparison of Adjustable-and Fixed-Rate Mortgages. Journal of Business, 66, 595-618.

[7]   Kau, J.B. and Keenan, D.C. (1995) An Overview of the Option-Theoretic Pricing of Mortgages. Journal of Housing Research, 6, 217-244.

[8]   Grenadier, S.R. (1995a) The Persistence of Real Estate Cycles. The Journal of Real Estate Finance and Economics, 10, 95-119.

[9]   Yavas, A. and Sirmans, C.F. (2005) Real Options: Experimental Evidence. The Journal of Real Estate Finance and Economics, 31, 27-52.

[10]   Berger, J.A., Sullivan, M.P. and Sood, S.S. (2009) Restructuring Non-Performing Commercial Real Estate Loans: A Lender’s Dilemma. Real Estate Finance Journal, 25, 5.

[11]   Hull, J.C. (2006) Options, Futures, and Other Derivatives. Sixth Edition, Prentice-Hall, Englewood Cliff.

[12]   Benninga, S. and Wiener, Z. (1997) The Binomial Option Pricing Model. Mathematica in Education and Research, 6, 27-34.

[13]   Benninga, S. and Wiener, Z. (1997) Binomial Option Pricing, the Black-Scholes Option Pricing Formula, and Exotic Options. Mathematica in Education and research, 6, 11-14.

[14]   La Jeunesse, E. (2013) Home Improvement Spending on Distressed Properties: 2011 Estimates. Joint Center for Housing Studies, Harvard University, N13-1.

[15]   Wheaton, W. (2010) A Fair and Easy Way to Fix the US Mortgage Crisis. Business Insider.

[16]   Bhutta, N., Dokko, J. and Shan, H. (2010) The Depth of Negative Equity and Mortgage Default Decisions. Division of Research & Statistics and Monetary Affairs, Federal Reserve Board.

[17]   Powell, M.J. (1994) A Direct Search Optimization Method That Models the Objective and Constraint Functions by Linear Interpolation. In: Gomez, S. and Hennart, J.-P., Eds., Advances in Optimization and Numerical Analysis: Mathematics and Its Applications, Springer Netherlands, 51-67.