European Financial Management, Vol. 00, No. 0, 2011, 1–28 doi: 10.1111/j.1468-036X.2011.00635.x A Pricing Framework for Real Estate Derivatives Frank J. Fabozzi EDHEC Business School and EDHEC Risk Institute, 400 Promenade des Anglais, BP 3116 06202 Nice Cedex 3, France E-mail: frank.fabozzi@edhec.edu Robert J. Shiller Yale University, New Haven, CT USA and MacroMarkets LLC E-mail: robert.shiller@yale.edu Radu S. Tunaru University of Kent, Canterbury, Kent Business School, Park Wood Road, CT2 7PE, UK E-mail: r.tunaru@kent.ac.uk Abstract New methods are developed here for pricing the main real estate derivatives — futures and forward contracts, total return swaps, and options. Accounting for the incompleteness of this market, a suitable modelling framework is outlined that can produce exact formulae, assuming that the market price of risk is known. This framework can accommodate econometric properties of real estate indices such as predictability due to autocorrelations. The term structure of the market price of risk is calibrated from futures market prices on the Investment Property Databank index. The evolution of the market price of risk associated with all five futures curves during 2009 is discussed. Keywords: derivatives pricing, real estate indices, incomplete markets, market price of risk , serial correlation JEL classification: G13, G15, G20 We thank John Doukas (the editor of this Journal) and the two anonymous referees for their help in improving the content and presentation of this article. Earlier versions of this article were presented at seminars at ICMA Reading and Judge Business School Cambridge as well as at conferences, Campus for Finance 2010 in Vallendar and the conference on Incomplete Markets, 2010 London. We also thank the participants at those events, in particular, Michael Dempster, Markus Harder, Tony Key, and Hashem Pesaran, for helpful comments; special thanks to Stuart Heath at EUREX, London for making the IPD UK futures data available. Correspondence: Frank J. Fabozzi. C  2011 Blackwell Publishing Ltd