The Variation of Economic Risk Premiums in Real Estate Returns.pdf

G. Andrew Karolyi * Anthony B. Sanders The Variation of Economic Risk Premiums in Real Estate Returns Abstract We examine the predictable components of returns on stocks, bonds, and real estate investment trusts (REITs). We employ a multiple-beta asset pricing model and find that there are varying degrees of predictability among stocks, bonds, and REITs. Furthermore, we find that most of the predictability of returns is associated with the economic variables employed in the asset pricing model. The stock market risk premium is highly important in capturing the predictable variation in stock portfolios, the bond market risk premiums (term and risk structure of interest rates) are important in capturing the predictable variation in bond portfolios. For REITs, however, both the stock and bond market risk premiums capture the predictable variation in returns. REITs have comparable return predictability to stock portfolios. We conclude that there is an important economic risk premium for REITs that are not captured by traditional multiple-beta asset pricing models. Version: April 1997. Comments welcome. * Karolyi is an Associate Professor of Finance at the Max M. Fisher College of Business of The Ohio State University; Sanders is The Galbreath Distinguished Scholar and a Professor of Finance at the Max Fisher College of Business of The Ohio State University. Financial assistance from the Dice Center for Research in Financial Economics was greatly appreciated. The authors would like to thank Wayne Ferson, Andy Naranjo and an anonymous referee for their helpful insights. The Variation of Economic Risk Premiums in Real Estate Returns 1. Introduction Are real