The influence of real estate risk on market volatility
| DOI | https://doi.org/10.1108/14635781111112774 |
| Pages | 145-166 |
| Published date | 08 March 2011 |
| Date | 08 March 2011 |
| Author | Chee Seng Cheong,Anna Olshansky,Ralf Zurbruegg |
| Subject Matter | Property management & built environment |
The influence of real estate risk
on market volatility
Chee Seng Cheong, Anna Olshansky and Ralf Zurbruegg
Business School, University of Adelaide, Adelaide, Australia
Abstract
Purpose – The purpose of this paper is to investigate the causal relationship between risk
experienced within the real estate industry and that of the overall market in the UK context. The
motivation behind this research is to investigate whether the real estate sector transmits risk to the
wider marketplace and whether this phenomenon existed, or was exacerbated, during the most recent
financial crisis.
Design/methodology/approach – The study was undertaken over a 20-year timeframe, from 1990
to 2010, with special attention being awarded to the global financial crisis (GFC) period from 2008 to
2010. The paper first undertakes graphical modeling of market and industry volatilities in an attempt
to identify which industry drives market uncertainty. This is followed by quantitative computation of
industry-specific volatility, which is employed in examining the relationship between these volatilities
using block exogeneity/Granger causality tests. Rolling sample analysis and impulse response
functions are employed as robustness tests to substantiate the main results.
Findings – First, the analysis confirms research that finance industry volatility is a leader in driving
market volatility. Second, it expands on these findings to identify the real estate sector as being a key
source of this causal relationship. It finds that real estate risk is the one that regularly drives finance
industry volatility over the 20-year sample period. Third, and most importantly, it emerges that the
causal link between the real estate sector and market volatility is at its strongest leading up to the most
recent financial crisis. More specifically, the real estate investment trusts sub-sector of real estate
industry volatility is the one that has the strongest unidirectional relationship with market-wide
volatility, both directly and indirectly, through driving the finance industry volatility during the GFC.
Originality/value – These findings are significant for market participants, such as pension funds,
which need to protect their assets from a stock market crash. Furthermore, anticipating a downturn by
observing the trends in real estate sector volatility is highly advantageous in informing their trading
strategies now and into the future. Policy makers likewise need a signal of an impending credit crunch
and can utilize real estate market statistics to pre-empt a freezing up of the credit markets.
Keywords Real estate, Financial risk, Financialservices, Economic fluctuations,United Kingdom,
Rish analysis
Paper type Research paper
1. Introduction
In light of the recent financial crisis, a paper examining the source of the extreme
market volatility that so devastated the world economy and financial markets is a very
appropriate research stream to pursue. Furthermore, the ability to isolate a sector of the
economy that causes overall market volatility can deliver both academic and practical
applications. Thus the motivation behind identifying whether industry-level risk, as
defined by Campbell et al. (2001), can cause uncertainty during a financial crisis is that
it would have useful applications for regulators, academics and market participants
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1463-578X.htm
The coauthors wish to acknowledge the support of the Australian Research Council Grant
DP1094848 in funding this research.
The influence of
real estate risk
145
Received August 2010
Accepted December 2010
Journal of Property Investment &
Finance
Vol. 29 No. 2, 2011
pp. 145-166
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781111112774
alike. Therefore, we aim to identify the impact of the real estate industry in
contributing and leading to changes in overall market risk. Furthermore, considering
the uncertainty initially generated by this sector in the USA, it would be interesting to
investigate whether this is also the case in a UK context.
Previous literature has examined the link between volatilities within certain sectors
of the economy and market indicators as identified in Rahman (2009), Campbell et al.
(2001) and Houston and Stiroh (2006). At the same time, the literature has expounded
on the significance of the real estate sector in influencing the wider economy as per
Hong et al. (2007) and Lizieri and Satchell (1997). However, these two lines of enquiry
have not yet been amalgamated to examine the role of industry-specific real estate
volatility in influencing overall market volatility. Furthermore, this unexamined causal
relationship has not been tested during times of financial crisis. The results of this
paper support previous findings made using US data that identify the finance sector as
a leading driver of the volatilities of the market and other industries as per Wang
(2010). However, our analysis digs deeper to unearth the underlying drivers of the
finance industry itself. As a result, the real-estate sector emerges as a significant
determinant of risk within the finance industry in many periods over a sample
spanning the last two decades. Most intriguing however is that this sector’s causal
properties increase dramatically in the lead-up to the most recent of financial crises.
The trend is uncovered by further decomposing the sector into real estate investment
and services and real estate investment trusts (REITs) (see Figure 1). By undertaking
this type of industry-focused analysis during the global financial crisis (GFC) period
we find that REITs are a major driver of finance industry risk as well as that of most
other sectors. Within this sub category, industrial and office REITs emerge as the
foremost leader. This forges an interesting link between risk in the real estate sector,
and in particular in its REITs component, and uncertainty throughout the finance
industry and therefore the market and economy as a whole. This could be interpreted
to mean that REITs, which pool resources into speculative investment, reveal a lot
about the wider market’s risk-taking appetite. Being able to ascertain the extent of this
appetite may facilitate premeditative action before a price bubble bursts.
Figure 1.
Sub-sectors of the finance
industry in the UK
JPIF
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