Monetary Shocks and REIT Returns

Abstract

We investigate the influence of unanticipated changes in US monetary policy on Equity Real Estate Investment Trusts (REIT’s). Although a number of studies have investigated the issue of interest rate changes, the effect of unanticipated changes has not previously been addressed in terms of possible effects on both REIT’s returns and volatility. The results show a strong response in both the first and second moments of REIT returns to unexpected policy rate changes. The results for the impact of the shock on both mean and volatility of returns is consistent with results from studies addressing broader equity markets. However, we find evidence both against behavioral changes in volatility coincident to US monetary policy decisions and asymmetric responses to the monetary policy shock.

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Notes

  1. 1.

    Note that this paper solely examines the response of Equity REITs and does not consider the Mortgage REIT sector.

  2. 2.

    See Allen et al. (2000), Chen et al. (1997), Chen and Tzang (1988), Devaney (2001), Liang and Webb (1995), Ling and Naranjo (1997), McCue and Kling (1994), Mueller and Pauley (1995) and Swanson et al. (2002).

  3. 3.

    He et al. (2003) highlight the importance of proxies by illustrating the sensitivity of results to the interest rate proxy used. They also find further evidence concerning the time-varying nature of the linkages between interest rates and real estate securities. Using a Flexible Least Squares approach the paper highlights that all of the proxies tested have time-varying characteristics.

  4. 4.

    Stevenson et al. (2005) adopt a similar methodological approach in their analysis of UK property companies and do find significant sensitivity in both the mean and variance equations using daily data.

  5. 5.

    Conover et al. (1999) also note the importance and influence of US monetary policy in an international context, while Lastrapes (1998) provides further international empirical evidence on the influence of monetary policy on equity markets.

  6. 6.

    An early paper to examine this is Waud (1970).

  7. 7.

    Roley and Troll (1984), Cook and Hahn (1988) and Dueker (1992) examine the issue of technical and non-technical rate changes in the context of the impact of policy rate changes on market interest rates.

  8. 8.

    Further papers to have examined issues concerned with macroeconomic data and stock movements include Berry and Howe (1994), Mitchell and Mulherin (1994), Ederington and Lee (1993) and Cutler et al. (1989).

  9. 9.

    Castanias (1979) provides an early study on the volatility of the markets surrounding the release of economic data.

  10. 10.

    We follow the approach used in Poole and Rasche (2000) and use the 1 month ahead contract (rather than the current month) to derive our surprise and so avoid making the adjustment as in Kuttner (2001).

  11. 11.

    Note that given the data period examined (1996–2005), it is not necessary to take into account the change in the operations of the Federal Reserve in 1994.

  12. 12.

    One possible reason behind this is that the impact of fed funds rate changes is more pronounced in smaller REITs and that this is driving the overall findings. However, tests on a corresponding small cap REIT portfolio also find insignificant results.

  13. 13.

    Our results may be considered to be consistent with the underlying thesis of the Bomfim (2003) study, i.e. that monetary policy transparency has increased dramatically post 1994.

  14. 14.

    Given the events of the first 9 months of 2001, the unusually large changes in monetary policy and the events of 9/11, we also incorporate a dummy variable into both the mean and variance equations. As can be seen from Table 3, the dummy variable is not statistically significant.

  15. 15.

    The detailed results for the large-cap REIT portfolio and the S&P 500 are available from the authors.

  16. 16.

    Tests of any possible asymmetry in the impact on returns was tested, but found not to exist.

  17. 17.

    When testing for possible asymmetry in the volatility response to shocks, we isolate positive and negative surprises on scheduled announcement days. In order to avoid potential multicollinearity in our results, we omit \( I^{{{\left( {{\text{sa}}} \right)}}}_{t} \) from the regression.

  18. 18.

    The detailed results for the large-cap REIT portfolio and the S&P 500 are available from the authors.

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Acknowledgement

The authors would like to thank the anonymous referees, seminar participants at Cass Business School, City University and the University of Amsterdam and participants at the Pacific-Rim Real Estate Society conference, the joint conference of the Asian Real Estate Society and the American Real Estate & Urban Economics Association and the 2006 Hong Kong–Singapore research symposium for comments on previous drafts of this paper.

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Correspondence to Simon Stevenson.

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Bredin, D., O’Reilly, G. & Stevenson, S. Monetary Shocks and REIT Returns. J Real Estate Finan Econ 35, 315–331 (2007). https://doi.org/10.1007/s11146-007-9038-6

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Keywords

  • US monetary policy
  • Equity Real Estate Investment Trusts
  • Monetary shocks
  • REIT returns