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Downward-sloping term structure of lease rates: a puzzle


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  • Seko, Miki
  • Sumita, Kazuto
  • Yoshida, Jiro


A model of the term structure of lease rates in a frictionless economy is developed and its predictions are compared with data on residential leases in Japan. The model shows that the initial lease rate for a cancellable lease must be set higher than that for a non-cancellable lease because the former rate will be repeatedly adjusted downward when the market rent decreases. More importantly, the term structure of lease rates is always upward-sloping for cancellable leases. Empirical findings show a sharp contrast with the theory. Fixed-term lease rates are often higher than open-ended long-term lease rates. Moreover, in the fixed-term lease sample, the term structure of lease rates is downward-sloping. The term structure is also heterogeneous by tenant’s income.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 37395.

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Date of creation: 29 Feb 2012
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Handle: RePEc:pra:mprapa:37395

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Keywords: lease contracts; term structure; cancellation option; hedonic regression; residential real estate; option premium; Japan;

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  1. McConnell, John J. & Schallheim, James S., 1983. "Valuation of asset leasing contracts," Journal of Financial Economics, Elsevier, Elsevier, vol. 12(2), pages 237-261, August.
  2. Brent Ambrose & Yildiray Yildirim, 2008. "Credit Risk and the Term Structure of Lease Rates: A Reduced Form Approach," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 37(3), pages 281-298, October.
  3. Iwata, Shinichiro, 2002. "The Japanese Tenant Protection Law and Asymmetric Information on Tenure Length," Journal of Housing Economics, Elsevier, Elsevier, vol. 11(2), pages 125-151, June.
  4. Agarwal, Sumit & Ambrose, Brent W. & Huang, Hongming & Yildirim, Yildiray, 2011. "The Term Structure of Lease Rates with Endogenous Default Triggers and Tenant Capital Structure: Theory and Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 46(02), pages 553-584, April.
  5. Steven R. Grenadier, 2005. "An Equilibrium Analysis of Real Estate Leases," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 78(4), pages 1173-1214, July.
  6. Miki Seko & Kazuto Sumita, 2007. "Japanese Housing Tenure Choice and Welfare Implications after the Revision of the Tenant Protection Law," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 35(3), pages 357-383, October.
  7. Clapham, Eric & Gunnelin, Åke, 2003. "Rental Expectations and the Term Structure of Lease Rates," SIFR Research Report Series, Institute for Financial Research 16, Institute for Financial Research.
  8. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, Elsevier, vol. 38(3), pages 297-331, July.
  9. Marshall E. Blume & Donald B. Keim, . "The Valuation of Callable Bonds," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 14-89, Wharton School Rodney L. White Center for Financial Research.
  10. Richard Stanton & Nancy Wallace, 2009. "An Empirical Test of a Contingent Claims Lease Valuation Model," Journal of Real Estate Research, American Real Estate Society, American Real Estate Society, vol. 31(1), pages 1-26.
  11. Eric Clapham & �ke Gunnelin, 2003. "Rental Expectations and the Term Structure of Lease Rates," Real Estate Economics, American Real Estate and Urban Economics Association, American Real Estate and Urban Economics Association, vol. 31(4), pages 647-670, December.
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