On Demand: Cross-Country Evidence From Commercial Real Estate Asset Markets
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Using over 25 years of quarterly US and Japanese time series data, this study examines the determinants of demand for an important class of durable, income producing real assets: commercial real estate. We specify a structural model of market equilibrium that considers direct effects of real investment on built asset price. Our research is partly motivated by the real option pricing model which originates from the option pricing model by Black, Scholes, and later refined by Merton. Our theoretical purpose is to investigate whether the real option approach can explain real estate market better than conventional models. In addition, using our theoretical model, our empirical purpose is to see whether commercial real estate markets are consistent across countries between US and Japan. Our empirical findings are consistent across countries and produce several new results. First, we find that real investment exerts a significant positive effect on asset price. Second, idiosyncratic risk is found to be strongly positively related to asset price, and to complement supply effects. Third, systematic risk is priced as expected, where the strength of the relation between asset price and systematic risk is found to be much higher than in previous studies of capital asset prices. Fourth, lagged values of price determinants are found to be important in real asset demand estimation. Alternative explanations for our findings are analyzed and discussed. Implications for asset pricing model specification and interpretation are also considered.