Testing the Dividend-Ratio Model on Real Estate Assets

Campbell and Shiller’s (1988) dividend-ratio model has long been adopted in various asset markets. It improves previous methods by incorporating time-varying discount rates theoretically. However, it is rarely applied to real estate markets, nor has its validity been tested on real estate assets. This paper uses the dividend-ratio model to examine the long-term relationship between the market capitalization rate and the growth-adjusted discount rate in the housing markets in Hong Kong. The empirical results show a significant and positive long-term relationship between these two series, which provides evidence that cap rate can reflect the market conditions in the long run and that a dynamic discounting model can help predict long-term cap rate.