Futures Trading, Spot Price Volatility and Market Efficiency: Evidence from European Real Estate Securities Futures

Abstract

In 2007 futures contracts were introduced based upon the listed real estate market in Europe. Following their launch they have received increasing attention from property investors, however, few studies have considered the impact their introduction has had. This study considers two key elements. Firstly, a traditional Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model, the approach of Bessembinder & Seguin (1992) and the Gray’s (1996) Markov-switching-GARCH model are used to examine the impact of futures trading on the European real estate securities market. The results show that futures trading did not destabilize the underlying listed market. Importantly, the results also reveal that the introduction of a futures market has improved the speed and quality of information flowing to the spot market. Secondly, we assess the hedging effectiveness of the contracts using two alternative strategies (naïve and Ordinary Least Squares models). The empirical results also show that the contracts are effective hedging instruments, leading to a reduction in risk of 64 %.

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Notes

  1. 1.

    To check the robustness of our baseline results, a robustness check was performed. Oct 2002 (5 years before the onset of futures trading) was selected. However, it did not change the conclusion of futures trading did not destabilise the underlying spot market.

  2. 2.

    A robustness check of the sensitivity of our results to currency denomination was also performed in which our models were re-run with the dataset in US dollar. Little variation was observed. Specifically, the baseline findings are robust in which no significant increase in volatility that is attributed to the introduction of futures trading.

  3. 3.

    Results from Augmented Dickey-Fuller and Phillips-Perron unit root tests show that all of the data is stationary. These results are available from the authors on request.

  4. 4.

    The GFC period is from September 2007–June 2009. This is consistent with the studies such as Newell (2010) and KnightFrank (2010) in which a recovery sign was evident since Q2, 2009. Robustness checks were also performed. Different periods were selected (1) Oct 07-Dec 09, (2) Sept 07-March 09 and (3) Oct 07-May 09. The robustness checks show that the preceding results are robust.

  5. 5.

    A unit root test was performed for these expected and unexpected components; the results show these variables are stationary.

  6. 6.

    Naturally, a third time dummy representing the pre-crisis period cannot be introduced as it would lead to perfect multicollinearity. Besides, the full sets of time dummy results are available from the authors.

  7. 7.

    Gulen & Mayhew (2000) do highlight the importance of accounting for movements in the world index in the consideration of changes in underlying volatility. To further control for the effect of other determinants of volatility, the FTSE Eurofirst 300 index, the FTSE Eurofirst 300 Eurozone Index as well as the S&P Global Property Index were introduced into our baseline models. Interestingly, the inclusions of these indices had little impact on our baseline results. The results also suggest that our results are robust to these alternative specifications. The full sets of results from these specifications are available from the authors on request.

  8. 8.

    Interestingly, a negative relationship is observed between the forward and spot housing markets in Hong Kong by Wong et al. (2006), confirming that futures/forwards trading may enhance the information flows and reduce spot volatility.

  9. 9.

    A robustness check with 10-day window was also performed, no significant difference was found. Thus, the baselines results are robust to the choice of estimation window. The full robustness results are available from the authors.

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Lee, C.L., Stevenson, S. & Lee, M. Futures Trading, Spot Price Volatility and Market Efficiency: Evidence from European Real Estate Securities Futures. J Real Estate Finan Econ 48, 299–322 (2014). https://doi.org/10.1007/s11146-012-9399-3

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Keywords

  • Real estate securities futures
  • GARCH
  • Volatility
  • Hedging effectiveness and Europe