Lead-Lag Relationship between the Real Estate Spot and Forward Contracts Markets
Yiu, C. Y., Hui, E. C. M., Wong, S. K., Journal of Real Estate Portfolio Management
Executive Summary. This study analyzes the lead-lag relationship between the spot and forward returns on direct real estate investments. Based on the forward price index (for which the term to maturity is zero) and the expost spot price index of residential property in Hong Kong, changes in information flow between the spot and forward markets are tested to see how they affect the lead-lag relationship. The findings suggest that (1) during periods of low-volume ratios (i.e., the forward market is relatively less active than the spot market), the spot return Granger causes the returns of forward contracts; and (2) during periods of higher-volume ratios, there are feedback relationships between the two markets.
Direct investments in property have been found in many previous studies to be superior to investment in stocks, as summarized in Norman, Sirmans and Benjamin (1995). Chiang and Ganesan (1996) found supporting evidence in the Hong Kong real estate markets. Despite their superior performance, including direct property investments in asset portfolios may incur very high transaction costs (Chua, 1999). One possible way to lower these transaction costs is to use direct property derivatives, such as property futures. However, the use of derivatives in direct property investments has received little attention in the literature, except for Chau, Wong and Yiu (2003) and Lai, Wang and Zhou (2004) who established pricing models for real estate pre-sale contracts. Their ideas are that although a formal futures market for direct property does not exist, developers can carry out preoccupation sales (pre-sales1) of new developments well before occupation, so as to transfer their financial risk and gauge the market value of properties. Such pre-sale arrangements are typical in many cities such as Hong Kong and Singapore, and are effectively forward contracts in the sense that the contracting parties have agreed on the price, but the subject property, which is still under construction, will be transferred to the assignee at a later date. In the light of this interpretation, this paper aims to contribute further to the understanding of the pre-sale market by examining the lead-lag relationship between the returns on real estate spot and forward contracts.
There are several reasons why it is of great interest to identify any lead-lag relationship between real estate forward and spot markets. First, practitioners or investors require this information to make their decisions about arbitrage. second, regulators need to know the impact of the real estate forward market on the spot one (or vice versa) to formulate more informed housing and land policies. Finally, existing research largely ignores futures or forward contracts in the real estate market. This is because (1) there is no centralized exchange for trading real estate futures, and (2) the turnover of pre-sales is relatively small in many markets. To tackle these problems, this paper takes advantage of the vast amount of housing pre-sales data in Hong Kong,2 which enables a quantitative study of the lead-lag relationship between the pre-sale market and the spot market of real estate. We hypothesize that their lead-lag relationship is dictated by the level of price information available to flow between the pre-sale market and the spot market. The proportion of the number of transactions in the two markets is taken as the proxy for measuring the information flow.
This paper is organized as follows: The next section reviews the literature concerning the lead-lag relationship between the future and spot prices in the financial market. This is followed by a discussion of the flow of in the information on prices between the forward contracts and spot markets in real estate. Next, the results of the Granger causality tests on the lead-lag relationship are presented. The final section presents concluding comments.
The lead-lag relationship between the spot and futures (also forward) markets has drawn considerable attention. …