Does Inflation Illusion Explain the Relation
between REITs and Inflation?
Bong Soo Lee
Published online: 4 November 2011
Springer Science+Business Media, LLC 2011
Abstract We examine whether the observed negative relations between real estate
investment trust (REIT) returns and inflation can be explained by the inflation
illusion. We identify the mispricing component in REIT prices based on present
value models, both linear and loglinear, and then we investigate whether inflation
can explain the mispricing component. When we allow for time-varying interest
rates, inflation no longer explains the REIT mispricing component. Instead, we find
that behavioral factors such as consumer sentiments contribute to the mispricing of
Keywords REIT returns
JEL Classifications G12
The relation between asset returns and inflation has been investigated extensively.
Contrary to the conventional view and the Fisher hypothesis, many empirical studies
find a negative relation between inflation and real stock returns in post-war data for
the U.S. and other countries (e.g., Bodie 1976; Jaffe and Mandelker 1976; Nelson
and Schwert 1977; Fama and Schwert 1977; Gultekin 1983; Geske and Roll 1983;
Lee 1989; Marshall 1992; Hess and Lee 1999).
Various theoretical frameworks (hypotheses) and empirical approaches have been
proposed to explain the observed relation between stock returns and inflation.
J Real Estate Finan Econ (2013) 47:123–151
College of Business, Sogang University, Mapo-Ku, Seoul, South Korea 121-742
B. S. Lee (*)
College of Business, Florida State University, Tallahassee, FL 32306-1110, USA