2015-02: Stochastic Taxation and REITS Pricing Bubbles: A Statistical Analysis

Using a modified Consumption Capital Asset Pricing Model (CCAPM) with stochastic taxation, we create estimates of fundamental values and fundamental overall rates of returns for United States Real Estate Investment Trusts (REITs) for our data sample, 1972 — 2013. Comparing actual, observed REITs prices (and overall rates of return) with model-generated fundamental values (and fundamental overall rates of return), we examine the presence of bubbles. For our purposes, for publicly traded equity REITs, we define a bubble to be the difference between actual stock market price (overall rates of return) and fundamental value (fundamental overall rate of return). United States REITs have, among other features, special rules governing dividend distributions and corporate taxation treatment that makes them an especially attractive and a preferred vehicle to test the presence of pricing and rate of return bubbles. Using this notion for bubbles, our study suggests that during the sample time horizon, United States REITs experienced statistically significant price and rates of return bubbles for a preponderance of the time.