An examination of the REIT return–implied volatility relation: a frequency domain approach

Abstract

This paper examines the relationship between implied volatility (the VIX) and REIT returns using frequency domain approach which allows shocks to vary across frequency bands. The distinguishing feature of the frequency domain method is that it enables the investigator assess quantitatively the impact of independent variables on the dependent variable at different frequencies across the spectra. The estimates of the parameter of interest from the frequency domain analysis may reveal rich policy implications. Specifically, at issue is whether implied volatility can be used to predict movements in REIT returns at different frequencies in the United States. The results from the frequency domain regression show that implied volatility and REIT returns have significantly negative effect on each other at the low-, medium- and long-term frequencies. Furthermore, the empirical findings from the frequency domain causality tests indicate that causality runs from implied volatility to all and equity REIT returns in the short- and medium-term frequencies but not vice versa. However, it is interesting to note that the results show causality running from mortgage REIT returns to implied volatility in the medium term. Taken together, the results from this study suggest that knowledge of implied volatility can help the investors to predict movements in the capital market and hence, to some extent, they can protect their portfolios against uncertainties.