Regime switching and asset allocation. Evidence from international real estate security markets
| DOI | https://doi.org/10.1108/14635780710746920 |
| Published date | 01 May 2007 |
| Date | 01 May 2007 |
| Pages | 274-288 |
| Author | K.H. Liow,H. Zhu |
| Subject Matter | Property management & built environment |
Regime switching and
asset allocation
Evidence from international real estate
security markets
K.H. Liow and H. Zhu
Department of Real Estate, National University of Singapore, Singapore
Abstract
Purpose – The purpose of this paper is to explore a regime switching asset allocation model that
includes six major real estate security markets (USA, UK, Japan, Australia, Hong Kong and Singapore)
and focuses on how the presence of regimes affects portfolio composition.
Design/methodology/approach – A Markov switching model is first developed to characterize
real estate security markets’ risk-return in two regimes. The mean-variance portfolio construction
methodology is then deployed in the presence of the two regimes. Finally, the out-of-sample analyzes
are conducted to examine whether the regime switching allocation outperforms the conventional
allocation strategy.
Findings – Strong evidence of regimes in the six real estate security markets in detected. The
correlations between the various real estate security markets’ returns are higher in the bear market
regime than in the bull market regime. Consequently the optimal real estate portfolio in the bear
market regime is very different from that in the bull market regime. The out-of-sample tests reveal that
the regime-switching model outperforms the non-regime dependent model, the world real estate
portfolio and equally-weighted portfolio from risk-adjusted performance perspective.
Originality/value – The application of the Markov switching technique to real estate markets is
relatively new and has great significance for international real estate diversification. With increased
significance of international securitized property as a real estate investment vehicle for institutional
investors to gain worldwide real estate exposure, this study provides significant insights into the
investment behavior and optimal asset allocation implications of the listed real estate when returns
follow a regime switching process.
Keywords Volatility,Asset management, Portfolio investment, Real estate
Paper type Research paper
1. Introduction
Recently, several studies have highlighted that listed real estate companies make a
significant contribution to the market capitalization of Asian stock markets (Liow and
Webb, 2006; Bond et al., 2003). Similarly, securitized real estate has become an
increasingly important real estate investment vehicle in Asia and internationally
(Steinert and Crowe, 2001), particularly through the success of REITs in the USA, LPT
in Australia, the recent establishment of equivalent vehicles in Japan, Korea, Singapore
and Hong Kong and the long-established track record of listed real estate companies in
Asia and Europe.
In the same vein, a number of studies have also highlighted the benefits of
international real estate diversification. These research studies have typically
developed correlation matrices in constructing efficient portfolios. In this process, real
The current issue and full text archive of this journal is available at
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JPIF
25,3
274
Received July 2006
Accepted November 2006
Journal of Property Investment &
Finance
Vol. 25 No. 3, 2007
pp. 274-288
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635780710746920
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