Academic journal article Journal of Real Estate Portfolio Management

Inflation Hedging Characteristics of the Chinese Real Estate Market

Academic journal article Journal of Real Estate Portfolio Management

Inflation Hedging Characteristics of the Chinese Real Estate Market

Article excerpt

Executive Summary. The Chinese real estate market has been experiencing rapid growth and transformation over the last few years. This paper tested the short-term inflation hedging characteristics of real estate markets in four major cities in China: Beijing, Chengdu, Shanghai and Shenzhen, using Autoregressive Integrated Moving Average models. The model restriction was relaxed by adding two macroeconomic factors: real GDP growth and real stock market return. The long-term relationship and causality between the real estate returns and inflation were also tested using country-level aggregate data. The results show no evidence of long-term hedging ability. However, the causality test shows that there is a significant unidirectional causality from the inflation to the real estate return.


Since the seminal paper by Fama and Schwert (1977), the relationship between real estate return and inflation has been a subject of extensive empirical research in the real estate literature. There are three motivations why the Chinese market is selected for analysis in this paper. First, the Chinese real estate market is highly speculative, and its inflation hedging characteristics may differ from other mature markets. Second, there is no published empirical evidence on the inflation hedging characteristics of the Chinese real estate market. Finally, as investment capital is pouring into direct real estate markets in China, it is important to have an understanding of the behavior of real estate investment returns and their hedging characteristics against inflation.

In this paper, the short-term inflation hedging ability of real estate returns is tested with quarterly data from 1996 to 2002 using the conventional ordinary least squares (OLS) methodology. Based on annual data over an extended sample period from 1988 to 2002, the long-term relationship between real estate returns and inflation is tested using cointegration analysis. The Granger causality test is also used to examine the causality relationships between real estate return and inflation.

Literature Review

The first empirical test of the relationship between asset returns and inflation was done by Fama and Schwert (1977). In their seminal paper, the returns of U.S. Treasury bills, long-term Treasury bonds, private residential real estate, human capital and common stocks were tested. They used the conventional OLS model to study the inflation hedging characteristics of these assets. The nominal Treasury-bill rate was used as the proxy for the expected inflation rate. The results showed that private residential real estate was the only asset that offered a complete hedge against both expected and unexpected inflation. In addition, the authors found that government debts were a complete hedge against expected inflation, whereas human capital was a partial hedge against expected and unexpected inflation. Common stocks were negatively related to expected and unexpected inflation.

Instead of using the Treasury-bill rate as a proxy for expected inflation rate, different forms of Autoregressive Integrated Moving Average (ARIMA) models were used [Barkham, Ward and Henry, 1996: ARIMA (1,1,3); and Gatzlaff, 1994: ARIMA (1,03)] to decompose the actual inflation rate into its expected and unexpected components. Barkham, Ward and Henry tested the long-term inflation hedging and causality relationships between U.K. property and the actual and the decomposed inflation rates. They found significant short-term relationships between expected and actual inflation and the direct real estate returns. They also found highly significant long-run relationships between the property returns and all the inflation rates in the cointegration tests. Tarbert (1996) extended the inflation hedging study to test the inflation-hedging characteristics of different property types.

Later, Stevenson (2000) examined the long-term relationship between inflation and the housing market, and found strong evidence that housing and inflation share a common long-term trend. …

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