Academic journal article Journal of Real Estate Portfolio Management

Volatility Transmission in Australian REIT Futures

Academic journal article Journal of Real Estate Portfolio Management

Volatility Transmission in Australian REIT Futures

Article excerpt

Executive Summary. This study aims to examine the volatility spillover in Australian REIT futures over the study period of 2004-2008. An Exponential-Generalized Autoregressive Conditional Heteroscedasticity (EGARCH) model is employed to analyze the volatility series of REIT futures. The results show that REIT futures are heavily influenced by REITs and stocks, suggesting that the news originated from these markets will affect REITs futures. The results also illustrates that the equity market is more influential than REITs in affecting the volatility of REIT futures. It is also shown that REIT futures are more sensitive to negative news than positive news. These findings have provided additional insights into the volatility patterns of property futures.

Real Estate Investment Trusts (REITs) have been one of the largest and most successful indirect property investment vehicles in Australia. In January 2008, 59 REITs were listed on the Australian Securities Exchange (ASX) with a total market capitalization of AUD$117.46 billion, representing around 9% of the total ASX market capitalization (AME, 2008; ASX, 2008). Currently, the Australian REIT market is the second largest REIT market in the world and accounts for approximately 14% of the total global REIT market capitalization (AME, 2008). In June 2007, over 4,300 commercial properties in Australia and overseas were managed by Australian REITs (PIR, 2007). Besides, almost 58% of the total commercial properties in Australia were owned and managed by Australian REITs (ABS, 2007).

Given the significance of the Australian REIT market, the Australian Stock Exchange1 introduced the first REIT futures in the world in 2002. This product has provided a more efficient risk management tool to institutional investors in managing their REIT portfolios. Nowadays, the REIT futures market has emerged as an appealing and effective tool for hedging, speculation, and arbitrage, as well as transition management to fund managers, asset allocators, and arbitrageurs. The increasing popularity of REIT futures among property investors and fund managers is also evident in recent years. As shown in Exhibit 1, the use of REIT futures has increased dramatically from 7,924 lots in July 2005 to 43,525 lots in December 2008. In December 2007, the transaction volume also achieved a record high, with 80,158 futures contracts valued at AUD$1.715 billion. More importantly, almost 80% of property investors (property funds) in Australia use derivatives, including REIT futures, for a range of investment and risk management reasons (Lee, 2009). For example, the Wholesale Australian Diversified Property Securities Fund employed futures for hedging the market risk (AXA, 2009).

More recently, the growth of property futures has also been witnessed in other countries such as the United States. The Chicago Board of Trade launched the Dow Jones U.S. Real Estate Index Futures contracts on January 21, 2007. This is the futures market based on the performance of U.S. real estate securities. Similar products for direct commercial real estate and housing were also launched by the Chicago Mercantile Exchange in early 2007 and May 2006, respectively, in the U.S. A rapid growth of property derivatives is also evident in the United Kingdom (Just and Feil, 2007). The total volume of property derivatives traded in the U.K. reached £11.2 billion. The total notional of trades executed in Q4:2008 was also five times higher than at the end of 2005. This figure is expected to reach £100 billion by 2010.

Even though property futures are considered as the relatively new investment product in property investment, futures markets are well established for stocks, cash, and other commodity markets. One of the areas of interest in the futures markets literature is the volatility linkages of futures markets and capital assets (stocks, bonds, and cash). Generally, most previous research has shown that there are strong volatility linkages between futures markets and those of spot markets. …

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