The stability of the co‐movements between real estate returns in the UK
| Pages | 434-442 |
| Date | 01 September 2006 |
| Published date | 01 September 2006 |
| DOI | https://doi.org/10.1108/14635780610691913 |
| Author | Stephen Lee |
| Subject Matter | Property management & built environment |
The stability of the co-movements
between real estate returns
in the UK
Stephen Lee
Centre for Real Estate Research (CRER),
The University of Reading Business School, Reading, UK
Abstract
Purpose – The usefulness of ex-post data as a proxy for ex-ante returns in the portfolio problem rests
on the stability of the co-movement between returns. Yet despite its importance, this issue has not
received sufficient examination in the financial literature, particularly in the direct real estate market.
This study aims to address this issue.
Design/methodology/approach – To examine the temporal stability of covariance and correlation
matrices and individual correlation coefficients this paper uses the Box M tests and the methodology
of Shaked using monthly real estate data in the UK over the period 1987 to 2002 and four investment
horizons.
Findings – The Box M tests reveal that the covariance and correlation matrices both display temporal
instability. This suggests that the returns between real estate returns are unstable over time and so provide
poor estimates in the ex-ante modelling process. The analysis also indicates that the covariance matrices
are less stable than the corresponding correlation matrices. Nonetheless, when we tested the stability of
individual correlation coefficients using the methodology of Shaked we find that stability increases
consistently and substantially with the lengthening of the investment horizon and holding period.
Practical implications – Thus, for all practical purposes the pair-wise correlation between real
estate returns can be considered nearly stationary in the long run. This implies that investors can use
ex-post data as a proxy for ex-ante data in portfolio models especially if longer investment horizons are
used to estimate the parameters.
Originality/value – This study is the first to examine temporal co-movements between UK real
estate returns in a portfolio context over different investment horizons.
Keywords Real estate, UnitedKingdom
Paper type Research paper
Introduction
Modern portfolio theory shows that the lower the correlation between investments the
greater the degree of portfolio risk reduction. Eun and Resnick (1987), however, argue
that the actual gains from diversification tend to be lower than the potential gains
because of estimation risk or parameter uncertainty. The degree of estimation risk is
dependent upon the temporal stability of the correlation matrix, which is estimated
from historic data. Yet, although there is complete agreement on the benefits of
diversification, research on the temporal behaviour of the co-movement between
returns is limited. In particular, while there is a considerable amount of work in the
equity market (see Cheung and Ho, 1991; Kaplanis, 1988; Meric and Meric, 1989;
Wahab and Lashgari, 1993) only two studies have examined this issue in the real estate
market (Eichholtz, 1996; Lee, 1998).
Using monthly data on property company indices from Datastream for nine
countries Eichholtz (1996) tested for inter-temporal stability in the covariance and
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JPIF
24,5
434
Received April 2006
Accepted June 2006
Journal of Property Investment &
Finance
Vol. 24 No. 5, 2006
pp. 434-442
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635780610691913
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