Equilibrium in Asset Leasing Markets

Using a framework analogous to models of the term structure of interest rates, an intertemporal rational expectations equilibrium for the term structure of lease rates is developed. While active firms lease existing units of an underlying real asset, idle firms choose optimal entry strategies upon which they undertake construction of new supply. The industry is characterized by shocks to both demand and construction costs. Using an option-pricing framework, entry strategies, rent, and asset values are determined endogenously in equilibrium. The term structure of lease rates is seen to have many features in common with standard models of interest rate term structures. The model is then applied to a wide variety of real-world leasing contracts. First, equilibrium rents on forward leases (“pre-leasing”) are determined. Second, options to renew or cancel a lease are valued. Third, leases with adjustable rents are analyzed. Finally, leases where the rent level is contingent upon the intensity of the asset’s use are modeled.