Regional and global contagion in real estate investment trusts. The case of the financial crisis of 2007‐2009
| DOI | https://doi.org/10.1108/14635781311292971 |
| Published date | 01 February 2013 |
| Pages | 53-77 |
| Date | 01 February 2013 |
| Author | George Milunovich,Stefan Trück |
| Subject Matter | Property management & built environment |
Regional and global contagion in
real estate investment trusts
The case of the financial crisis of 2007-2009
George Milunovich
Department of Economics, Macquarie University, North Ryde, Australia, and
Stefan Tru
¨ck
Department of Applied Finance and Actuarial Studies, Macquarie University,
North Ryde, Australia
Abstract
Purpose – The purpose of this paper is to investigate contagion between real estate investment
trusts (REITs) within and across three geographical regions: North America, Europe and Asia-Pacific.
The paper also examines excess comovement between the considered national REIT markets on the
one hand, and broad equity indices on the other. In particular, the authors are interested in contagion
between the considered markets during the 2007-2009 GFC period in comparison to the entire
2004-2011 sample period.
Design/methodology/approach – Using an international factor pricing framework similar to
Bekaert, Harvey and Ng, the paper defines contagion as excess comovement between two financial
markets, after removing the effects of the underlying economic fundamentals, i.e. risk factors, and
time-changing volatility. Controlling for economic factors is important for distinguishing between
pure contagion and information spillovers, which may transmit through existing economic channels.
The authors then analyse excess correlations between the derived standardized residuals, for REITS
and equity markets in order to investigate excess comovement between the indices during the whole
sample and GFC period.
Findings – The paper finds no evidence of excess comovement between the considered REIT and
equity indices during non-crisis sample intervals. However, the paper finds contagion between several
national REITs and regional or global equity markets during the GFC period. The paper reports
statistically significant excess correlations between national REITs and regional and world real estate
markets during the entire sample period, while there is only limited evidence to suggest that the
correlation amongst REIT markets has increased during the GFC period. The paper concludes that a
similar degree of dependence persisted among national REIT markets over the crisis and non-crisis
sample periods for most markets.
Originality/value – Despite the ongoing debate on contagion in financial markets, there is only a
small body of literature investigating contagion specifically for property or real estate markets. This is
even more surprising, since the GFC originated from a subprime mortgage crisis and was, therefore,
heavily related to real estate. The paper extends the literature by testing for contagion between REITs
considering eleven national markets across three geographical regions. In contrast, the existing
literature is typically constrained to a significantly smaller number of markets. The paper also
explicitly takes into account the impact of the recent GFC, and tests for contagion over this period.
Keywords REITS, Contagion,Financial crisis, Internationalfactor model, Real estate, North America,
Europe
Paper type Research paper
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1463-578X.htm
This research was supported under Australian Research Council’s Discovery Projects funding
scheme (project number DP1096326 and DP120102239).
Regional and
global contagion
53
Received May 2012
Accepted September 2012
Journal of Property Investment &
Finance
Vol. 31 No. 1, 2013
pp. 53-77
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781311292971
1. Introduction
Financial contagion broadly describes the observation that links between financial
markets strengthen during periods of financial crises, relative to benchmark relations
measured during periods of normalcy. This phenomenon is of concern to both
investors and policy makers alike because it implies that financial crises can spread to
markets, and asset classes, with no underlying exposure to the source of risk. Under
this scenario traditional risk management practices that rely upon stable historical
relations between assets are likely to fail, and more research is needed in order to shed
light on the full scope of the problem. Given the magnitude of the recent 2007-2009
credit crunch the issue of financial contagion is currently one of the most debated
topics in finance. The debate first originated from the extensive literature dealing with
financial crises and the propagation of shocks across geographically or economically
unrelated markets, such as the South-East Asian crisis (1997), the Russian debt crisis
(1998), the economic crises in Brazil and Argentina (1999-2002), and the most recent
period of worldwide financial turmoil during the 2007-2009 global financial crisis
(GFC). Despite the ongoing debate on contagion in financial markets, there is only a
small body of literature investigating contagion specifically for property or real estate
markets. This is even more surprising, since the GFC originated from a subprime
mortgage crisis and was, therefore, heavily related to real estate.
In this paper, we extend the existing literature on financial contagion by testing for
contagion in real estate investment trusts (REITs). Specifically, we attempt to answer
three main questions:
(1) is there contagion between national REIT markets within and across the
regions of North America, Europe and Asia-Pacific;
(2) what is the extent of contagion between the national REITs and broad equity
indices; and
(3) does the degree of contagion change during the recent GFC period.
Our study is different from the existing literature in two main aspects. First,
we consider 11 national markets across three geographical regions. In contrast, the
existing literature is typically constrained to one geographical area, or a significan tly
smaller number of major global markets. Second, we explicitly take into account the
impact of the recent GFC, and test for an increase in the frequency of contagion over
this period, relative to the remainder of the sample.
In our analysis we follow the definition of contagion as excess comovement,
i.e. comovement beyond the degree that could be justified by the economic fundamentals
affecting asset returns. Note that comovements or spillover effects between financial
markets also exist during periods of “normal” market behaviour, being driven by
fundamental factors that determine the interaction between the markets. However, the
literature on contagion suggests that the comovement may increase due to transmission
of shocks above what fundamental linkages would predict (Dornbusch et al., 2000;
Forbes and Rigobon, 2002). The increased comovement may be due to rational and
irrational decision-making by market participants such as herding behaviour, preferred
habitat and portfolio readjustments (Barberis et al., 2005; Boyer, 2011). In such a
situation the excess comovements are then attributed to contagion effects.
REITs were originally designed as a tax vehicle for corporations investing in real
estate assets. They are required to distribute a high fraction of their income into the
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