Interest rate risk and time‐varying excess returns for Asian property stocks

Publication Date01 May 2006
AuthorKim Hiang Liow,Qiong Huang
Interest rate risk and
time-varying excess returns for
Asian property stocks
Kim Hiang Liow and Qiong Huang
Department of Real Estate, National University of Singapore, Singapore
Purpose – Aims to investigate whether the level and volatility of interest rates affect the excess
returns of major Asian listed property markets within a time-varying risk framework.
Design/methodology/approach – A three-factor model is employed with excess return volatility,
interest rate level and interest rate volatility as its factors. The generalized autoregressive
conditionally heteroskedasticity in the mean (GARCH-M) analyzes are undertaken on monthly excess
returns of property stock indexes for the period 1987-2003.
Findings – Property stocks are generally sensitive to changes in the long-term and short-term
interest rates and to a lesser extent, their volatility. Moreover, there are disparities in the magnitude as
well as direction of sensitivities in interest rate level and volatility across the listed property markets
and under different market conditions. Overall, results indicate changes in the ARCH parameter, risk
premia, volatility persistence and interest rate level and volatility effects before and after the 1997
Asian financial crisis. However, these noted changes are not uniform and depend on the individual
listed property markets.
Originality/value – The findings enhance investors’ understanding in financial asset pricing and
complement existing evidence in international real estate. With the increasing significance of property
stocks as real estate investment vehicles for international investors to gain property exposure in Asia
and internationally, the paper is timely and provides the basis for more advanced research in
international real estate investment strategies and capital asset pricing.
Keywords Interest rates,Property, Singapore, Hong Kong, Japan,United Kingdom
Paper type Research paper
1. Introduction
Investors in real estate can choose to hold it directly by investing in physical
(unsecuritzed) property, or indirectly through the purchase of shares in Real Estate
Investment Trusts (REITs) or real estate operating companies, in short, real estate
companies. In countries such as the UK, Hong Kong and Singapore, given the relative
absence of REITs, the stocks of these companies, commonly known as property stocks,
provide an important investment opportunity to obtain exposure to the stock market
and the underlying property assets that comprise these portfolios. Specifically listed
property companies have become an increasingly important property investment
vehicle in Asia and internationally. With recent studies such as Steinert and Crowe
(2001) and Conover et al. (2002) highlighting the diversification benefits and added
value of including international listed property in a mixed asset portfolio, considerable
research has focused on performance analysis in Asian markets and the
inter-relationship between the respective securitized and unsecuritized real estate
markets[1]. However, there is lack of knowledge by international investors on the
The current issue and full text archive of this journal is available at
Received September 2004
Accepted July 2005
Journal of Property Investment &
Vol. 24 No. 3, 2006
pp. 188-210
qEmerald Group Publishing Limited
DOI 10.1108/14635780610659919
impact of changes in interest rates on time-varying excess returns and
return-generating process of property stocks in Asian markets. Another key concern
is that with two parallel markets (i.e. stock market and physical property market) for
trading real estate assets, it is very likely that property stock return and volatility
characteristics are different from those of stock markets (especially) in the long term.
Thus, research results from the stock markets should not be automatically extend ed to
the property stock markets[2]. Additionally, property stocks are also different from
REITs in their organizational form, tax status, regulatory framework and investment
performance[3]. A body of empirical knowledge in time-varying risk-return dynamics
and equilibrium asset pricing of property stocks should thus add significantly to the
international real estate literature.
One interesting issue appeared in the financial asset pricing literature is the impact
of interest rate risk and pricing in the stock markets for banks and financial
institutions. Prior studies such as Chance and Lane (1980), Flannery and James (1984),
Mansur (1995), Flannery et al. (1997) and Elyasiani and Mansur (1998) have provided
consistent evidence that stock returns are sensitive to interest rate movements and that
unanticipated real interest rate is relevant in the pricing of common stocks. Similarly,
several studies in the USA, UK and Singapore have observed that returns of direct real
estate, REITs and property companies are influenced by interest rate movements[4].
However, many of these studies did not include an assessment of the effect of the
changes in the interest rate volatility on the time-varying excess returns of property
companies. As high interest rate volatility can adversely affect spending and economic
activity and thereby affect property company earnings and excess stock returns, it is
important to incorporate the volatility effect, in addition to the level effect, in asset
pricing models.
The resulting key investment issue is whether the level and volatility of interest
rates affect the excess returns of property stocks within a time-varying risk
framework. In this study, a three-factor model is employed with excess return
volatility, interest rate level and interest rate volatility as its factors. While this issue
has been examined for the US REITs, the increasingly significant role of Asian
property companies also requires the critical assessment of this key investment issue
for major Asian property stock markets. Using the generalized autoregressive
conditionally heteroskedastic in the mean (GARCH-M) methodology on monthly
excess returns of property stock indexes of three major Asian markets (Singapore,
Hong Kong, Japan) and the UK for the period 1987-2003 and two shorter-sample
periods (i.e. pre-1997 Asian financial crisis and post-1997 Asian financial crisis
periods), the specific objectives of this research are[5]:
.To develop a three-factor APT model that includes excess return volatility,
interest rate level and interest rate volatility as its factors in a time-varying
.To assess and compare the property stock excess return volatility, persistence of
volatility and risk premia across markets and across the two short-sample
periods (i.e. pre-crisis period and post-crisis period). Since the long-term and
short-term interest rates and their volatility might affect property stock returns
differentially, these variables are included in alternative specifications.
Asian property

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