Research On Valuation And Asymmetric Effect Of Cancellation Option In Residential Lease Contracts

Improving the residential rental market is of great significance to facilitate the healthy and sustainable development of real estate industry. The underdeveloped rental market will not only lead to high housing prices, but also influence people’s consumption choices. In China, people are reluctant to solve living demand through rental market, but more willing to buy houses. The main reason for causing this phenomenon is the lack of tenant protection. Within the term of the contract, landlords can take back the houses at any time and evict the tenants. The existence of landlords’ right of cancellation brings great sense of instability to tenants, which results in the disorder of rental market. Nearly all of the developed countries have prohibited this right, however, the negative effect brought by this right has not been paid enough attention in our country at present.To explore the value of landlords’right of cancellation, firstly the option theory is used to explain this right. Secondly, under the frame of risk neutral, a rent term structure of standard lease is presented. Then the cancellation option is introduced into the model and a pricing model of the lease with cancellation option is established. By making assumptions about the parameters, it can be found that the contract rent of a lease with cancellation option is lower than that of the standard lease and Black-Scholes model can be used to price the option.In the part of empirical research, firstly an asset price valuation formula, which includes the growth rate of income, is derived. This confirms that the price-to-rent ratio is mainly affected by the expected rate of return and growth rate of income. A residual can be derived after eliminating the impacts of expected rate of return and growth rate of income from the price-to-rent ratio. The difference between the residuals of different countries can truly reflect the real difference between price-to-rent ratio of different countries. Through the comparison of the residuals of China and the United States, this paper proves that the existence of cancellation option does affect our country’s rent.Then, this paper analyzes the effect of cancellation option to both the landlords’ and tenants’ welfare. It is found that although cancellation option brings benefits to landlords, it brings greater losses to tenants. This paper theoretically analyzes the asymmetric effect of this option to the two parties and estimates this asymmetry through case study. The conclusion is that prohibiting cancellation option can bring net increase of social welfare. Based on the above conclusion, some related policy suggestions are put forward.