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Article Excerpt
We construct synchronously priced indices of securitized property listed on the New York Stock Exchange and London Stock Exchange. The indices are then utilized to examine dynamic information flows between the two markets. By analyzing returns behavior, asymmetric volatility spillover effects and exceedance correlations, this study shows that the real estate markets in these two countries experience significant interaction on a daily basis when synchronously priced data are utilized. These results are different from when close-to-close returns are examined, implying that the use of close-to-close data can misconstrue the true dynamics that exist between these markets. Results also show significant asymmetric effects on both the volatility and correlation dynamics between the markets. This has several implications for property portfolio managers, indicating that positive and negative news impact the markets differently. This is particularly true for the United Kindom, where daily foreign news from the United States can influence U.K. volatility.
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In this study, we provide an analysis of the pricing dynamics shared between the U.S. and U.K. securitized real estate markets. To date, property research has failed to examine the daily dynamics inherent between the various international property markets and the implications it has for property portfolio performance. Specifically, little attention has been placed on examining contemporaneously quoted property prices for the markets operating in different time zones and the asymmetry effects that foreign news can have on a local property market, despite it being the norm for most financial analyses on equity and fixed-income instruments.
One reason for this may be the property sector being considered by many to behave differently in the way they interact with other financial assets and international markets. Although securitized property markets may well interact with one another, the immobile nature of the underlying physical asset leads to demographics and geography being generally viewed as major determinants for the value of property. These localized factors are therefore considered to be more important than perhaps foreign daily news events that impact other financial assets, which can also lead to a greater co-movement between assets in different countries.
This may also explain why there is evidence that property markets are less globally integrated than other financial assets. With less integration between national property sectors, correlations would normally be expected to be lower and the benefits to diversification higher. For instance, Asabere, Kleiman and McGowan (1991), in a study on the role of indirect property holdings in a mixed asset portfolio over the 1980-1988 period, demonstrated that there were benefits to international diversification of real estate assets. These researchers found low positive correlations between U.S. real estate investment trusts (REITs) and international real estate equities. This finding was supported in a study conducted by Hudson-Wilson and Stimpson (1996). These analysts examined the inclusion of U.S. securitized real estate in Canadian property portfolios over the period 1980-1994, finding that Canadian investors would have benefited by the inclusion of U.S. real estate in their portfolios.
In a more extensive study that included nine countries from 1985 to 1994, Eichholtz (1996) found significantly lower cross-country correlations for real estate returns than for either common stock or bond returns--implying greater segmentation in real estate than other assets. Eichholtz suggested that a possible reason for the lower correlations for real estate may be that real estate is more influenced by local factors than is the case for either stocks or bonds.
Apart from evidence suggesting property markets are less integrated with one another, there is also very little evidence showing real estate markets are susceptible to daily information flows that arrive from local and foreign sources. In one of the few studies on the link between news events and real estate, Schwann and Chau (2003) looked at news effects and structural shifts in price discovery (the information transfer from securitized to direct real estate) in Hong Kong over the period 1986-1999. Their expectation was that there would be a less than full transfer of information from indirect to direct property markets as a result of news events if such "news" was external to the real estate sector. To test their hypothesis the events considered by these authors were abnormally large returns in the securitized property sector that were occasioned by general international capital market movements. The outcome from their analysis supported their expectation in that these authors found the price discovery effect to be significantly reduced in the period following such news events. Glascock, Michayluk and Neuhasuser (2004) also show that the riskiness of REITs to market downturns may be less than with other equity. This, in part, is probably due to the specific features underlying the value of securitized stocks, that being physical property.
This paucity of research on the subject is, in part, due to the lack of available high-frequency observations for the direct appraisal property market other than, possibly, monthly statistics. However, the same cannot be said for the securitized realty market for equity listed property holding companies. Although there is some contention that an analysis of securitized property will not necessarily lead to the same results as that for direct property, there is a growing amount of the literature showing the strong relationship between the two. Namely, indirect property markets seem to move with an approximate 6-9 month lead time over the direct market. As property holding companies are fundamentally priced on the value of their physical assets, there is no reason to suspect the two markets will deviate very far from each other over the long term. Research by Kallberg, Liu and Pasquariello (2002), for instance, has shown that the correlations between direct and indirect property returns for Asian real estate markets are relatively strong, with the securitized market leading to changes in the direct, physical market. Barkham and Geltner (1995) also show, in a study on price discovery for the U.S. and U.K. real estate markets, pricing behavior did transmit from indirect to direct property markets with varying time lags. (1)
As there has effectively been no detailed study of daily pricing dynamics for the international real estate market, this article analyzes daily information flows between two of the most heavily traded securitized property markets in the world, the United States and United Kingdom. By constructing synchronously priced realty indices for property holding companies trading on the London Stock Exchange (LSE) and the New York Stock Exchange (NYSE), this study examines the pricing dynamics that exist between these two markets and provides an indication of the time-varying correlation structure that exists. This is achieved by estimating the variance-covariance structure of the markets using an asymmetric covariance GARCH model proposed by Kroner and Ng (1998). This will allow for asymmetric volatility spillover effects to be observed, along with accounting for an asymmetry in the correlation dynamics from negative and positive news shocks entering both the markets. This is of invaluable importance given it has been shown that, for more common equity indices, asymmetric effects can be quite large and can have an impact on the benefits to diversification (see Martens and Poon 2001). Also, and as a means of comparison, exceedance correlations are calculated, following the methodology of Ang and Chen (2002). This will allow for another means to analyze the asymmetry of the correlation structure between the two markets.
The rest of the article examines the above in more detail. The next section explains how the data were constructed. The third section details the methodology employed to examine pricing dynamics, with the fourth section providing the empirical results. The final section concludes with comments on the significance of the results discussed in this article for property portfolio managers.
The Data and Preliminary Statistics
In order to examine the pricing dynamics between the U.S. and U.K. securitized property markets, the issue of synchronicity first needs to be addressed. Research by Martens and Poon (2001) has shown that the use of close-to-close returns can underestimate return correlations for markets that trade at different times. Moreover, previous studies, such as by Hamao, Masulis and Ng (1990) and Koutmos and Booth (1995), who only utilized opening and closing prices, have found it difficult to differentiate between contemporaneous and lagged spillover pricing effects...
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