Real Estate and the Arbitrage Pricing Theory: Macrovariables vs. Derived Factors

Two empirical models are used to implement the arbitrage pricing theory: the factor loading model (FLM) and the macrovariable model (MVM). This study compares the ability of these two models to explain real estate returns using equity REIT returns as a proxy. Two tests are performed: a comparison of cross-sectional adjusted-R2's and the Davidson and Mackinnon test. The results show that while the two models perform equally well during the period 1974 - 1979,the MVM outperforms the FLM over the periods 1980 - 1985 and 1986 - 1991. In addition, both models suggest superior financial performance for EREITs relative to other investments in the market during the period 1980 - 1985.

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