AN EXAMINATION OF THE ROLE OF SECURITY CLAUSES AND DEPOSITS IN RESIDENTIAL LEASE CONTRACTS

This paper argues that security clauses in lease contracts create a co ntingent claim on the value of the leased property, which resembles a put option on common stock. Adapting the standard results from option pricing theory gives insight into how landlords determine security dep osit amounts, which serve to guarantee performance of the contract. Em pirical tests show that deposit amounts are affected by the propensity of a property to be damaged, the propensity of a tenant to cause dama ge, and other characteristics of the landlord-tenant relationship. Two -stage least squares and probit regression estimates, however, provide only limited evidence to suggest that advance deposits significantly reduce tenant damages in the residential rental market.