Discount Shock, Price-Rent Dynamics, and the Business Cycle

Jianjun Miao, Pengfei Wang, and Tao Zha
Working Paper 2020-7
May 2020

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Abstract: The price-rent ratio in commercial real estate is highly volatile, and its variation comoves with the business cycle. To account for these two facts, we develop a dynamic general equilibrium model that explicitly introduces a rental market and incorporates the liquidity constraint on an individual firm's production as a key ingredient. Our estimation identifies the discount shock as the most important factor in driving price-rent dynamics and linking the dynamics in the real estate market to those in the real economy. We illustrate the importance of the liquidity premium and endogenous total factor productivity (TFP) in the nexus of the financial and real sectors.

JEL classification: E22, E32, E44

Key words: comovements, liquidity premium, stochastic discount factor, asset pricing, production economy, heterogenous firms, endogenous TFP, general equilibrium link

The authors thank Mark Bils, Larry Christiano, Marty Eichenbaum, Jordi Galí, Lars Hansen, Simon Gilchrist, Pat Higgins, Lee Ohanian, Sergio Rebelo, Richard Rogerson, Giorgio Valente, Gianluca Violante, Wei Xiong, and seminar participants at the University of Pennsylvania, the University of North Carolina, the NBER Summer Institute, the AFR Summer Institute of Economics and Finance, the PBC Finance School of Tsinghua University, the Hong Kong Monetary Authority, the University of Toronto, Vanderbilt University, and the University of Rochester for helpful discussions. The research is supported in part by the National Science Foundation grant SES 1558486 through the NBER and by the National Natural Science Foundation of China Research grants (71473168, 71473169, and 71633003). The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or the National Bureau of Economic Research. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Jianjun Miao, Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215; Pengfei Wang, Department of Economics, Hong Kong University of Science and Technology, Hong Kong and Peking University HSBC Business School, China; or Tao Zha, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, and Emory University and also NBER.

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