Academic journal article International Journal of Business

An International Perspective of Volatility Spillover Effect: The Case of REITs

Academic journal article International Journal of Business

An International Perspective of Volatility Spillover Effect: The Case of REITs

Article excerpt

ABSTRACT

We study the 1999-2011 period for volatility spillover between US and European real estate markets. The sample period is divided into pre-crisis (1999-2007) and post-crisis (2007-2011) periods. Real estate investment is proxied by the performance of equity REITs, private real estate indices and real estate firms. We document an asymmetric volatility spillover effect from U.S. markets to European markets. The primary result is the finding of volatility transmission from U.S. real estate markets to European real estate markets emanating from public U.S. real estate investment (S&P REIT index). However, there is no strong evidence that European markets spill over to U.S. real estate markets for either public or private real estate.

JEL Classifications: C30; G10; R30

Keywords: volatility spillover; GARCH; REITs

I. INTRODUCTION

In managing a global portfolio where the risk-adjusted return, such as the Sharpe ratio, is a primary focus, the size of correlation and the change in correlation over time are critical factors. Global diversification is beneficial to the extent that managers are successful in risk reduction, i.e. allocating capital to low correlation markets. Risk reduction is not easily attainable once co-movements between the securities or between the markets increase significantly usually due to systematic events like the Asian Financial Crisis in 1997 and real estate meltdown in 2007. In particular, investors add real estate to an existing portfolio to increase yield, hedge against inflation, and reduce the overall risk of the portfolio. Investing in international real estate properties and real estate investment trusts (REITs) became increasingly popular after the collapse of technology firms and the rise in bankruptcies in the early 2000s in the United States and other countries. The purpose of this paper is to examine the volatility transmission effect from the U.S. real estate (public and private) to the real estate markets of Europe and vice versa. Returns, volatility, and the risk/return ratios of the indexes are also examined.

We study the 1999-2011 period for volatility spillover between the U.S. and European real estate markets. The sample period is divided into two mutually exclusive sub periods: pre-crisis (1999-2007) and post-crisis (2007-2011). Note the rumors about Lehman Brothers were spreading in late 2007, and the actual bankruptcy occurred in 2008 followed by other crisis events. Therefore, splitting the period around the year 2007 is warranted in terms of the timing of the crisis. Real estate investment performance is proxied by several measures for robustness: equity REITs, private real estate indices and real estate firms. The primary result is the finding of volatility transmission from public U.S. real estate markets to public European real estate markets. However, there is no strong evidence that European markets spillover to U.S. real estate markets for either the public or private real estate.

There is a sizeable volume of research in the area of intermarket volatility effect. The authors believe this research is relatively unique not only in terms of focusing on REITS and the periods before and after crisis, it also examines the volatility effect in four directions: the US (private) to Europe, Europe to the U.S. (private), the U.S. (public) to Europe, and Europe to the U.S. (public).

We organize this paper into six sections. In Section II, we offer a selected review of the literature on volatility transmission effect. Sections III and IV describe the methodology and the data used in this study, respectively. The empirical results are provided in Section V followed by a summary conclusion in Section VI.

II. LITERATURE REVIEW

A number of studies focused on inter-market volatility transmission effect after the financial crisis of the 1990s and the early 2000s during which corporate bankruptcies increased and many technology firms failed. …

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