Valuation and arbitrage

The use of discounted cash flow (DCF) methods in investment valuation and appraisal is argued by many academics as being rational and more rigorous than the traditional capitalisation model. However those advocates of DCF should be cautious in their claims for rationality. The various DCF models all rely upon an all-encompassing equated yield (IRR) within the calculation. This paper will argue that this is a simplification of the risk perception which the investor places on the income profile from property. In determining the long term capital value of a property an 'average' DCF method will produce the 'correct' price, however, the individual short term values of each cash-flow may differ significantly. In the UK property market today, where we are facing a period in which prices are not expected to rise generally at the same rate or with such persistence as hitherto, investors and tenants are increasingly concerned with the down side implications of rental growth and investors may indeed be interested in trading property over a shorter investment horizon than they had originally planned. The purpose of this paper is therefore to bring to the analysis a rigorous framework which can be used to analyse the constituent cash flows within the freehold valuation. We show that the arbitrage analysis lends itself to segregating the capital value of the cash flows in a way which is more appropriate for financial investors

The uncertainty of valuation

Valuation is often said to be “an art not a science” but this relates to the techniques employed to calculate value not to the underlying concept itself. Valuation is the process of estimating price in the market place. Yet, such an estimation will be affected by uncertainties. Uncertainty in the comparable information available; uncertainty in the current and future market conditions and uncertainty in the specific inputs for the subject property. These input uncertainties will translate into an uncertainty with the output figure, the valuation. The degree of the uncertainties will vary according to the level of market activity; the more active a market, the more credence will be given to the input information. In the UK at the moment the Royal Institution of Chartered Surveyors (RICS) is considering ways in which the uncertainty of the output figure, the valuation, can be conveyed to the use of the valuation, but as yet no definitive view has been taken. One of the major problems is that Valuation models (in the UK) are based upon comparable information and rely upon single inputs. They are not probability based, yet uncertainty is probability driven. In this paper, we discuss the issues underlying uncertainty in valuations and suggest a probability-based model (using Crystal Ball) to address the shortcomings of the current model.

Can company-fund manager meetings convey informational benefits? Exploring the rationalisation of equity investment decision making by UK fund managers

Conventional economic theory, applied to information released by listed companies, equates ‘useful’ with ‘price-sensitive’. Stock exchange rules accordingly prohibit the selec- tive, private communication of price-sensitive information. Yet, even in the absence of such communication, UK equity fund managers routinely meet privately with the senior execu- tives of the companies in which they invest. Moreover, they consider these brief, formal and formulaic meetings to be their most important sources of investment information. In this paper we ask how that can be. Drawing on interview and observation data with fund managers and CFOs, we find evidence for three, non-mutually exclusive explanations: that the characterisation of information in conventional economic theory is too restricted, that fund managers fail to act with the rationality that conventional economic theory assumes, and/or that the primary value of the meetings for fund managers is not related to their investment decision making but to the claims of superior knowledge made to clients in marketing their active fund management expertise. Our findings suggest a disconnect between economic theory and economic policy based on that theory, as well as a corre- sponding limitation in research studies that test information-usefulness by assuming it to be synonymous with price-sensitivity. We draw implications for further research into the role of tacit knowledge in equity investment decision-making, and also into the effects of the principal–agent relationship between fund managers and their clients.

Food marketing technology and contingency market valuation

Marketing activities are introduced into a rational expectations model of the food marketing system. The model is used to evaluate effects of alternative marketing technologies on the distribution of the benefits of contingency markets in agriculture. Benefits depend on two parameters: the cost share of farm inputs and the elasticity of substitution between farm and nonfarm inputs in food marketing. Over a broad spectrum of technologies, consumers are likely to be the net beneficiaries and farmers the net losers from the provision of contingency markets

Seasonality and the valuation of commodity options

Price movements in many commodity markets exhibit significant seasonal patterns. However, given an observed futures price, a deterministic seasonal component at the price level is not relevant for the pricing of commodity options. In contrast, this is not true for the seasonal pattern observed in the volatility of the commodity price. Analyzing an extensive sample of soybean, corn, heating oil and natural gas options, we find that seasonality in volatility is an important aspect to consider when valuing these contracts. The inclusion of an appropriate seasonality adjustment significantly reduces pricing errors in these markets and yields more improvement in valuation accuracy than increasing the number of stochastic factors.

Valuation 'accuracy' within the Right to Buy process

Based on surveys undertaken with local authorities and valuers who provide the valuations on which purchase prices for local authority houses under the Right to Buy are based, this paper reports on research which aims to establish the reasons for the differences between the initial valuations provided by the local authority valuers and those provided by the District Valuer on appeal. The paper reports on the reasons why tenants appeal the initial valuation and discusses issues of valuation accuracy, uncertainty and the different and imperfect data available to valuers employed by the organisations involved, as well as the factors within the valuation process, including the absence of any requirement to agree a value, which contribute to the different outcomes.

Commercial real estate and equity market bubbles: are they contagious to REITs?

This paper uses a regime-switching approach to determine whether prices in the US stock, direct real estate and indirect real estate markets are driven by the presence of speculative bubbles. The results show significant evidence of the existence of periodically partially collapsing speculative bubbles in all three markets. A multivariate bubble model is then developed and implemented to evaluate whether the stock and real estate bubbles spill over into REITs. The underlying stock market bubble is found to be a stronger influence on the securitised real estate market bubble than that of the property market. Furthermore, the findings suggest a transmission of speculative bubbles from the direct real estate to the stock market, although this link is not present for the returns themselves.

Can valuation factors be prescribed? The case of collective enfranchisement and leasehold extension of flats in England and Wales

Recent concerns over the valuation process in collective leasehold enfranchisement and lease extension cases have culminated in new legislation. To underpin this, the Government (Department of Environment Transport and the Regions (DETR)) commissioned new research, which examined whether the valuation of the freehold in such cases could be simplified through the prescription of either yield or marriage value/relativity. This paper, which is based on that research, examines whether it is possible or desirable to prescribe such factors in the valuation process. Market, settlement and Local Valuation Tribunal (LVT) decisions are analysed, and the basis of 'relativity charts' used in practice is critically examined. Ultimately the imperfect nature of the market in freehold investment sales and leasehold vacant possession sales means that recommendations must rest on an analysis of LVT data. New relativity curves are developed from this data and used in conjunction with an alternative approach to valuation yields (based on other investment assets). However, the paper concludes that although the prescription of yields and relativity is possible, it is not fully defensible because of problems in determining risk premia; that the evidential basis for relativity consists of LVT decisions; and that a formula approach would tend to 'lead' the market as a whole.

A conceptual valuation framework (VF) for home telecare system devices

Purpose – The aim of this paper is to present a conceptual valuation framework to allow telecare service stakeholders to assess telecare devices in the home in terms of their social, psychological and practical effects. The framework enables telecare service operators to more effectively engage with the social and psychological issues resulting from telecare technology deployment in the home and to design and develop appropriate responses as a result. Design/methodology/approach – The paper provides a contextual background for the need for sociologically pitched tools that engage with the social and cultural feelings of telecare service users before presenting the valuation framework and how it could be used. Findings – A conceptual valuation framework is presented for potential development/use. Research limitations/implications – The valuation framework has yet to be extensively tested or verified. Practical implications – The valuation framework needs to be tested and deployed by a telecare service operator but the core messages of the paper are valid and interesting for readership. Social implications – In addressing the social and cultural perspectives of telecare service stakeholders, the paper makes a link between the technologies in the home, the feelings and orientations of service users (e.g. residents, emergency services, wardens, etc.) and the telecare service operator. Originality/value – The paper is an original contribution to the field as it details how the sociological orientations of telecare technology service users should be valued and addressed by service operators. It has a value through the conceptual arguments made and through valuation framework presented.

An experimental test of response consistency in contingent valuation

We compare hypothetical and observed (experimental) willingness to pay (WTP) for a gradual improvement in the environmental performance of a marketed good (an office table). First, following usual practices in marketing research, subjects’ stated WTP for the improvement is obtained. Second, the same subjects participate in a real reward experiment designed to replicate the scenario valued in the hypothetical question. Our results show that, independently of the degree of the improvement, there are no significant median differences between stated and experimental data. However, subjects reporting extreme values of WTP (low or high) exhibit a more moderate behavior in the experiment.