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Testing the Dividend Discount Model in Housing Markets: the Role of Risk

Ge Bao () and Guoliang Feng ()
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Ge Bao: University of International Business and Economics
Guoliang Feng: China Investment Corporation

The Journal of Real Estate Finance and Economics, 2018, vol. 57, issue 4, 677-701

Abstract: Abstract Tests of the dividend discount model (DDM) applied to housing have studied the trade-off between the capitalization rate (CAP rate) and subsequent house price appreciation. Even allowing for attenuation bias because of actual appreciation does not equal expected appreciation, evidence for the DDM is not strong. This research has included an implicit assumption that risks associated with housing investment are common across housing markets. In addition, many previous tests have used the Bureau of Labor Statistics (BLS) Rent Index to construct the CAP rate although recent research by Ambrose et al. (2015) has questioned this data. The American Housing Survey is used to construct estimates of the CAP rate which is then combined with standard appreciation measures to estimate total return and its variance over time for larger Metropolitan Statistical Areas (MSA) in the U.S. Using statistically constructed estimates of the CAP rate and adding variance in total return to conduct tests of the DDM produces far stronger results than those obtained in previous studies of a cross section of cities in the U.S. But, when the BLS Rent Index is used to measure CAP rates and risk, the results are not consistent with DDM.

Keywords: Risk adjustment; Capitalization rate; BLS rent index; Dividend discount model (search for similar items in EconPapers)
JEL-codes: G10 R21 (search for similar items in EconPapers)
Date: 2018
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The Journal of Real Estate Finance and Economics is currently edited by Steven R. Grenadier, James B. Kau and C.F. Sirmans

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Handle: RePEc:kap:jrefec:v:57:y:2018:i:4:d:10.1007_s11146-017-9626-z