Academic journal article Real Estate Economics

Regime Shifts in Asian Equity and Real Estate Markets

Academic journal article Real Estate Economics

Regime Shifts in Asian Equity and Real Estate Markets

Article excerpt

This paper applies a new statistical technology for identifying regime shifts to analyze recent data on real estate and equity markets in eight developing Far Eastern countries in the 1992-1998 time period. We find that regime shifts in volatility occur in the summer of 1997; however, most of the regime shifts in returns occur in the spring of 1998. While the clustering of regime breaks does not seem to follow any obvious pattern, the country's exposure to trade and firm leverage are important. An analysis of Granger causality suggests that, in most cases, equity returns cause real estate returns but the converse is not true. We also find two-way causality in volatility, suggesting that a common factor drives volatility in these markets. Finally, we provide evidence that the regime shifts generally imply higher relative risk for real estate securities after the estimated breaks.


The recent upheaval in the Far East has made economists reevaluate the relations among financial markets on the international stage and also within each country. The crisis, commonly dubbed the Asian flu, began on July 1997 with the devaluation of the Thai baht. It quickly spread through all nations in the Far East, although with widely differing intensity and duration. A commonly reported driver of this crisis was the banking sector's overextension of credit to real estate. Allegedly, as real estate markets plummeted, banks suffered enormous losses due to their exposure to real estate developers; these problems then spread to the rest of the financial sector. (1) For example, for Thailand, Frank Flatters (2000, p. 261) offers the following analysis:

Among the factors contributing to the vulnerability of the system were the following: large and growing short-term liabilities relative to foreign reserves, which themselves were rapidly diminishing as the Bank of Thailand tried to maintain the baht's peg; the increasing oversupply of real estate, especially in Bangkok, which hurt the property and construction sectors directly, and also threatened the value of the principal form of collateral used in much bank lending.

A related, pithy observation comes from Paul Krugman (1999, p. ix):

How did a few bad real estate loans and a botched devaluation in Thailand--a small, faraway country of which most people knew little--send dominoes toppling from Indonesia to South Korea?

We will show that one effect of the crisis was to reduce real estate returns and to increase real estate volatility and correlation with other asset classes. But this general effect played out differently across the individual countries. The real estate indexes of China, Korea, Malaysia, and Thailand peaked in 1995, well before the start of the crisis. This suggests that the events of 1997 and 1998 should have affected these countries differently than those whose real estate markets continued to be strong into 1997.

While a wide variety of explanations for the crisis have emerged, including poor corporate governance, lack of proper banking supervision, IMF bungling, hedge fund herding, and so forth, much of the problem seemed to center in real estate markets. It is thus interesting to analyze how real estate and equity markets reacted during the time around the crisis. While a number of other studies have focused on the returns themselves, typically searching for increases in correlations, (2) our approach is different. We proceed in two stages. The first question we address is Granger causality: During this time period did real estate lead equity (stocks) or vice versa? We examine this question both for the return and volatility of real estate and equity in each country. The existence of Granger causality then motivates the second, and perhaps more interesting question: Did the crisis fundamentally change the relation between real estate and equity markets, or was it merely a manifestation of the natural dependencies in these markets? …

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