Assessing the Real Estate Pricing Puzzle: A Diagnostic Application of the Stochastic Discounting Factor to the Distribution of REIT Returns

  • David H. Downs


This article applies a general asset-pricing framework and the volatility bounds methodology of Hansen and Jagannathan (1991) to REIT returns. The state of real estate asset pricing remains somewhat of a puzzle relative to the identification of state variables and the structural form of models. This article offers a framework whereby real estate asset-pricing models and data can be diagnosed to answer questions about the shortcomings. In addition, several nominated discount processes are investigated for success in pricing real estate securities. Although the nominated specifications demonstrate some success in satisfying the restrictions on the first and second moments of the real estate returns distribution, they do not successfully price the securities under a no-arbitrage condition. This result calls into question previous real estate performance studies that employ these risk-adjustment processes.

real estate returns stochastic discount factor asset pricing 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Abel, A. (1990). ""Asset Prices Under Habit Formation and Catching Up with the Joneses,” American Economics Review 80, 38-42.Google Scholar
  2. Bakski, G. S., and A. Naka. (1997). ""An Empirical Investigation of Asset Pricing Models Using Japanese Stock Market Data,” Journal of International Money and Finance 16, 81-112.Google Scholar
  3. Belduzzi, P., and H. Kallal. (1997). ""Risk Premia and Variance Bounds,” Journal of Finance 52, 1913-1949.Google Scholar
  4. Bansal, R., and S. Viswanathan. (1993). ""No Arbitrage and Arbitrage Pricing: A New Approach,” Journal of Finance 48, 1231-1262.Google Scholar
  5. Bekaert, G., and R. J. Hodrick. (1992). ""Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets,” Journal of Finance 47, 467-509.Google Scholar
  6. Brueggeman, W., A. Chen, and T. Thibodeau. (1984). ""Real Estate Investment Funds: Performance and Portfolio Considerations,” AREUEA Journal 12, 33-354.Google Scholar
  7. Burnside, C. (1994). ""Hansen-Jagannathan Bounds as Classical Tests of Asset-Pricing Models,” Journal of Business and Economic Statistics 12, 57-79.Google Scholar
  8. Campbell, J. Y. (1987). ""Stock Returns and the Term Structure,” Journal of Financial Economics 18, 373-399.Google Scholar
  9. Campbell, J., and J. Cochrane. (1997). By Force of Habit: AConsumption-Based Explanation of Aggregate Stock Market Behavior. Manuscript, Harvard University and University of Chicago.Google Scholar
  10. Campbell, J. Y., A. W. Lo, and A. C. MacKinley. (1997). The Econometrics of Financial Markets. Princeton, NJ: Princeton University Press.Google Scholar
  11. Cechetti, S. G., P-S. Lam, and N. C. Mark. (1994)""``Testing Volatility Restrictions on Intertemporal Marginal Rates of Substitution Implied by Euler Equations and Asset Returns,” Journal of Finance 49, 123-152.Google Scholar
  12. Chan, K. C., P. H. Hendershott, and A. B. Sanders. (1990). ""Risk and Return on Real Estate: Evidence from Equity REITs,” AREUEA Journal 18, 431-452.Google Scholar
  13. Chen, S., C. Hsieh, and B. Jordan. (1997). ""Real Estate and the Arbitrage Pricing Theory: Macrovariables vs. Derived Factors,” Real Estate Economics 25, 505-523.Google Scholar
  14. Chen, Z., and P. Knez. (1996). ""Portfolio Performance Measurement: Theory and Applications,” Review of Financial Studies 9, 511-555.Google Scholar
  15. Chen, N.-F., R. Roll, and S. A. Ross. (1986). ""Economic Forces and the Stock Market: Testing the APT and Alternative Asset Pricing Theories,” Journal of Business 59, 383-403.Google Scholar
  16. Cochrane, J. (1992). ""Explaining the Variance of Price-Dividend Ratios,” Review of Financial Studies 5, 243-280.Google Scholar
  17. Cochrane, J., and L. Hansen. (1992). ""Asset Pricing Explorations for Macroeconomics.” In O. J. Blanchard and S. Fischer (eds.), NBER Macroeconomics Annual 1992 (pp. 115-165). Cambridge, MA: MIT Press.Google Scholar
  18. Connor, G. (1984). ""A Uni®ed Beta Pricing Theory,” Journal of Economic Theory 34, 13-31.Google Scholar
  19. Constantinides, G. M. (1990). ""Habit Formation: A Resolution of the Equity Premium Puzzle,” Journal of Political Economy 98, 519-543.Google Scholar
  20. Epstein, L., and S. Zin. (1989). ""Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework,” Econometrica 57, 937-969.Google Scholar
  21. Ferson, W. E. (1989). ""Changes in Expected Security Returns, Risk, and the Level of Interest Rates,” Journal of Finance 44, 1191-1217.Google Scholar
  22. Gallant, A. R., L. P. Hansen, and G. Tauchen. (1990). ""Using Conditional Moments of Asset Payoffs to Infer the Volatility of Intertemporal Marginal Rates of Substitution,” Journal of Econometrics 45, 141-179.Google Scholar
  23. Geltner, D. (1989). ""Estimating Real Estate's Systematic Risk from Aggregate Level Appraisal-Based Returns,” AREUEA Journal 17, 463-481.Google Scholar
  24. Glascock, J. L. (1991). ""Market Conditions, Risk and Real Estate Portfolio Returns: Some Empirical Evidence,” Journal of Real Estate Finance and Economics 4, 367-373.Google Scholar
  25. Glascock, J. L., and W. T. Hughes. (1995). ""NAREIT Identified Exchange Listed REITs and Their Performance Characteristics: 1972-1991,” Journal of Real Estate Literature 3, 63-83.Google Scholar
  26. Glascock, J. L., and C. Lu. (1997). Risk Dimensions of Real Estate Investment Trusts. Manuscript, University of Connecticut.Google Scholar
  27. Goetzmann, W. N., and R. G. Ibbotson. (1990). ""The Performance of Real Estate as an Asset Class,” Journal of Applied Corporate Finance 3, 65-76.Google Scholar
  28. Gyourko, J., and D. Keim. (1992). ""What Does the Stock Market Tell Us About Real Estate Returns?” AREUEA Journal 20, 457-485.Google Scholar
  29. Hagiwara, M., and M. A. Herce. (1997). ""Risk Aversion and Stock Price Sensitivity to Dividends,” American Economic Review 87, 738-745.Google Scholar
  30. Hansen, L. (1982). ""Large Sample Properties of Generalized Method of Moments Estimators,” Econometrica 50, 1029-1054.Google Scholar
  31. Hansen, L. P., J. Heaton, and E. Luttmer. (1995). ""Econometric Evaluation of Asset Pricing Models,” Review of Financial Studies 8, 237-274.Google Scholar
  32. Hansen, L., and R. Jagannathan. (1991). ""Implications of Security Market Data for Models of Dnamic Economies,” Journal of Political Economy 99, 225-262.Google Scholar
  33. Hansen, L., and S. F. Richard. (1987). ""The Role of Conditioning Information in Deducing Testable Restrictions Implied by Dynamic Asset Pricing Models,” Econometrica 55, 587-613.Google Scholar
  34. Harrison, J. M., and D. M. Kreps. (1979). ""Martingales and Arbitrage in Multiperiod Securities Markets,” Journal of Economic Theory 2, 381-408.Google Scholar
  35. Hartzell, D., J. Hekman, and M. E. Miles. (1987). ""Real Estate Returns and Inflation,” AREUEA Journal 15, 616-637.Google Scholar
  36. Ibbotson, R., and L. Siegel. (1984). ""Real Estate Returns: A Comparison with Other Investments,” AREUEA Journal 12, 219-242.Google Scholar
  37. Jensen, M. (1968). ""The Performance of Mutual Funds in the Period 1945-1964,” Journal of Finance 23, 443-455.Google Scholar
  38. Karolyi, G. A., and A. B. Sanders. (1998). ""The Variation of Economic Risk Premiums in Real Estate Returns,” Journal of Real Estate and Economics 17, 2452-62.Google Scholar
  39. Kraus, A., and R. H. Litzenberger. (1976). ""Skewness Preference and the Valuation of Risk Assets,” Journal of Finance 31, 1085-1100.Google Scholar
  40. Ling, D., and A. Naranjo. (1997). ""Economic Risk Factors and Commercial Real Estate Returns,” Journal of Real Estate Finance and Economics 14, 283-307.Google Scholar
  41. Liu, C., D. J. Hartzell, and T. Grissom. (1992). ""The Role of Coskewness in the Pricing of Real Estate,” Journal of Real Estate Finance and Economics 5, 299-319.Google Scholar
  42. Liu, C., and J. Mei. (1992). ""The Predictability of Returns on Equity REITs and Their Co-Movement with Other Assets,” Journal of Real Estate Finance and Economics 5, 401-418.Google Scholar
  43. Liu, C., and J. Mei. (1994). ""An Analysis of Real Estate Risk Using the Present Value Model,” Journal of Real Estate Finance and Economics 8, 5-20.Google Scholar
  44. Lucas, R. E., Jr. (1978). ""Asset Prices in an Exchange Economy,” Econometrica 46, 1429-1445.Google Scholar
  45. Lusht, K. M. (1988). ""The Real Estate Pricing Puzzle,” AREUEA Journal 16, 95-104.Google Scholar
  46. Marschak, J. (1938). ""Money and the Theory of Assets,” Econometrica 6, 311-325.Google Scholar
  47. Mehra, R., and E. C. Prescott. (1985). ""The Equity Premium: A Puzzle,” Journal of Monetary Economics 15, 145-161.Google Scholar
  48. Mei, J., and A. Lee. (1994). ""Is There a Real Estate Factor Premium?,” Journal of Real Estate Finance and Economics 9, 113-126.Google Scholar
  49. Mei, J., and C. Liu. (1994). ""The Predictability of Real Estate Returns and Market Timing,” Journal of Real Estate Finance and Economics 8, 115-135.Google Scholar
  50. Miles, M., and T. McCue. (1982). ""Historic Returns and Institutional Real Estate Portfolios,” AREUEA Journal 10, 184-199.Google Scholar
  51. Miles, M., and T. McCue. (1984). ""Commercial Real Estate Returns,” AREUEA Journal 12, 355-377.Google Scholar
  52. Newey, W. K., and K. D. West. (1987). ""A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix,” Econometrica 55, 703-708.Google Scholar
  53. Peterson, J., and C. Hsieh. (1997). ""Do Common Risk Factors in the Returns on Stocks and Bonds Explain Returns on REITs?,” Real Estate Economics 25, 321-345.Google Scholar
  54. Ross, S. (1976). ""The Arbitrage Theory of Capital Asset Pricing,” Journal of Economic Theory 13, 341-360.Google Scholar
  55. Rubinstein, M. (1976). ""The Valuation of Uncertain Income Streams and the Pricing of Options,” Bell Journal of Economics 7, 407-425.Google Scholar
  56. Sharpe, W. F. (1966). ""Mutual Fund Performance,” Journal of Business 39, 119-138.Google Scholar
  57. Smith, K. V., and D. Shulman. (1976). ""The Performance of Equity Real Estate Investment Trusts,” Financial Analysts Journal 32, 61-66.Google Scholar
  58. Snow, K. (1991). ""Diagnosing Asset Pricing Models Using the Distribution of Asset Returns,” Journal of Finance 46, 955-983.Google Scholar
  59. Titman, S., and A. Warga. (1986). ""Risk and the Performance of Real Estate Investment Trusts: A Multiple Index Approach,” AREUEA Journal 14, 414-431.Google Scholar
  60. Young M. S., and R. A. Graff. (1995). ""Real Estate Is Not Normal: A Fresh Look at Real Estate Return Distributions,” Journal of Real Estate Finance and Economics 10, 225-259.Google Scholar

Copyright information

© Kluwer Academic Publishers 2000

Authors and Affiliations

  • David H. Downs
    • 1
  1. 1.Terry College of BusinessUniversity of GeorgiaAthens

Personalised recommendations