ARTICLE | International Economic Review | Vol.61, No.3, 2020

Abstract

The price-rent ratio in commercial real estate is highly volatile and its variation comoves with the business cycle. To account for these facts, we develop a dynamic general equilibrium model that 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 TFP in the nexus of the financial and real sectors.