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An Empirical Test of a Contingent Claims Lease Valuation Model

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  • Richard Stanton

    (University of California, Berkeley)

  • Nancy Wallace

    ()
    (University of California, Berkeley)

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    Abstract

    Despite the importance of leases in the US economy, and the existence of several theoretical lease pricing models, there has been little systematic attempt to estimate these models. This paper proposes a simple no-arbitrage based lease pricing model, and estimates it using a large proprietary data set of leases on several property types. We also define a new measure, the Option-Adjusted Lease Spread, or OALS (analogous to an option’s implied volatility, or a mortgage-backed security’s Option-Adjusted Spread), that allows us to compare leases with different maturities and contract terms on a consistent basis. We find sizeable pricing errors that cannot be explained using interest rates, lease maturity, or information on the options embedded in the contracts. This suggests either that there are significant mispricings in the market for real estate leases, or that lease terms depend heavily on unobservable, property-specific characteristics.

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    File URL: http://aux.zicklin.baruch.cuny.edu/jrer/papers/pdf/past/vol31n01/01.1_26.pdf
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    Bibliographic Info

    Article provided by American Real Estate Society in its journal journal of Real Estate Research.

    Volume (Year): 31 (2009)
    Issue (Month): 1 ()
    Pages: 1-26

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    Handle: RePEc:jre:issued:v:31:n:1:2009:p:1-26

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    Postal: American Real Estate Society Clemson University School of Business & Behavioral Science Department of Finance 401 Sirrine Hall Clemson, SC 29634-1323
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    Web page: http://www.aresnet.org/

    Order Information:
    Postal: Diane Quarles American Real Estate Society Manager of Member Services Clemson University Box 341323 Clemson, SC 29634-1323
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    Web: http://aux.zicklin.baruch.cuny.edu/jrer/about/get.htm

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    References

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    1. Xavier Gabaix & Arvind Krishnamurthy & Olivier Vigneron, 2007. "Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market," Journal of Finance, American Finance Association, vol. 62(2), pages 557-595, 04.
    2. Hendershott, Patric H & Ward, Charles W R, 2003. "Valuing and Pricing Retail Leases with Renewal and Overage Options," The Journal of Real Estate Finance and Economics, Springer, vol. 26(2-3), pages 223-40, March-May.
    3. Wheaton William C. & Torto Raymond G., 1994. "Office Rent Indices and Their Behavior over Time," Journal of Urban Economics, Elsevier, vol. 35(2), pages 121-139, March.
    4. McConnell, John J. & Schallheim, James S., 1983. "Valuation of asset leasing contracts," Journal of Financial Economics, Elsevier, vol. 12(2), pages 237-261, August.
    5. Webb, R. Brian & Fisher, Jeffrey D., 1996. "Development of an Effective Rent (Lease) Index for the Chicago CBD," Journal of Urban Economics, Elsevier, vol. 39(1), pages 1-19, January.
    6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    7. Peter ENGLUND & Åke GUNNELIN & Martin HOESLI & Bo SÖDERBERG, 2002. "Implicit Forward Rents as Predictors of Future Rents," FAME Research Paper Series rp59, International Center for Financial Asset Management and Engineering.
    8. Ambrose, Brent W & Hendershott, Patric H & Klosek, Malgorzata, 2002. "Pricing Upward-Only Adjusting Leases," The Journal of Real Estate Finance and Economics, Springer, vol. 25(1), pages 33-49, July.
    9. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    10. Schallheim, James S & McConnell, John J, 1985. " A Model for the Determination of "Fair" Premiums on Lease Cancellation Insurance Policies," Journal of Finance, American Finance Association, vol. 40(5), pages 1439-57, December.
    11. John L. Glascock & Shirin Jahanian & C. F. Sirmans, 1990. "An Analysis of Office Market Rents: Some Empirical Evidence," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 18(1), pages 105-119.
    12. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, vol. 38(3), pages 297-331, July.
    13. William N. Goetzmann & Jonathan E. Ingersoll, Jr. & Stephen A. Ross, 2004. "High Water Marks," Yale School of Management Working Papers ysm22, Yale School of Management.
    14. Schallheim, James S. & Johnson, Ramon E. & Lease, Ronald C. & McConnell, John J., 1987. "The determinants of yields on financial leasing contracts," Journal of Financial Economics, Elsevier, vol. 19(1), pages 45-67, September.
    15. Benjamin, John D. & Boyle, Glenn W. & Sirmans, C. F., 1992. "Price discrimination in shopping center leases," Journal of Urban Economics, Elsevier, vol. 32(3), pages 299-317, November.
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    Cited by:
    1. Seko, Miki & Sumita, Kazuto & Yoshida, Jiro, 2012. "Downward-sloping term structure of lease rates: a puzzle," MPRA Paper 37395, University Library of Munich, Germany.

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