The real estate risk premium:A developed/emerging country panel data analysis

The objective of this paper is to identify the determinants of office capitalization rates for a panel of 52countries (developed and emerging countries) between 2000 and 2006. Our assumption, based on a CapitalAsset Pricing Model, is that the capitalization rate should be at least proportional to the country’s riskperception, as measured by the risk premium on the 10-year government bond yield. Because of theendogeneity of the latter variable, our empirical methodology requires that we estimate first a modelexplaining the 10-year bond yield. It will be the occasion to discuss the determinants of the risk premium onthe bond market. Using a SURE random effect Hausman-Taylor estimator (Hausman & Taylor, 1981), wealso take into account the possible correlation between the country risk characteristics on the bond marketsand those that determine the real estate market. Our results show that government bond yield is the maindeterminant of the capitalization rate. We estimate that a 1 percentage point increase in the government bondyield will raise the capitalization rate by about 0.19 percentage point. Real estate variables play also a role,but to a lesser extent. Turning to determinants of the 10-year bond yield, macroeconomic fundamentals aresignificant determinants of the country risk premium, especially the capacity to honor short-term financialengagements. In addition, the country’s risk history has also very important effect on the investors’ currentrisk perception....