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

Abstract

This paper 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 paper 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 succcessfully price the securities under a no-arbitrage condition. This result calls into question previous real estate performance studies that employ these risk-adjustment processes.

JEL Classification: G12