The Relationship between Unsecuritized Real Estate Price Index Volatility and Securitized Real Estate Price Index Volatility in the U.S.
Authors:   Asia-Europe Perspective Association, Yoo Han-Soo 
Published: June 2018

This paper provides empirical evidence of the link between unsecuritized real estate market and securitized real estate market in the U.S.. To understand these relationship is important to practicing portfolio management. To manage the risk of portfolio that includes REITs, a portfolio manager must know how sensitive REIT price is to other asset prices. If REIT prices are sensitive to real estate price, a portfolio which includes REITs is sensitive to real estate price. REIT price might reflect real estate market fundamentals because their major income is from real estate, and reflect stock market fundamentals because they are listed in the stock market. Both unsecuritized and securitized real estate prices are caused by cash flows from rents. Therefore, the same fundamental factors might influence both sectors. To pursue this point further, price volatility observed in the market is decomposed into the permanent volatility and transitory volatility. This study employs GARCH model to estimate observed volatility, and employs unobserved component model to estimate permanent volatility and transitory volatility. This study contributes to the literature by scrutinizing the relationship between the permanent volatility of unsecuritized real estate and the permanent volatility of securitized real eatate and the relationship between the transitory volatility of unsecuritized real estate and the transitory volatility of securitized real estate.
The S&P/Case-Shiller Home Price Index Composite of 10 is used for unsecuritized real estate market, and NAREIT Equity Residential Index is used for securitized real estate market. This study uses monthly time-series data from January 2000 to May 2012.
The procedure and results of this paper are as follows. First, GARCH model is used to estimate the observed volatilities of S&P/Case-Shiller Home Price Index and NAREIT Equity Residential Index. Second, unobserved component model is used in order to estimate permanent volatility and transitory volatility.
Third, ADF test is applied to test for the stationarity of data. The appropriate lag order is determined by the SC. ADF test results show that all the volatilities have not unit roots. Therefore, Granger causality test in a VAR should be applied.
Fourth, Granger causality tests based on VAR is applied, since each time-series data has not a unit root. The Granger causality tests show that, in the case of observed volatility, there are two-way Granger causalities between the observed volatility of S&P/Case-Shiller Home Price Index and the observed volatility of NAREIT Equity Residential Index. In the case of permanent volatility, there are two-way Granger causalities between the permanent volatility of S&P/Case-Shiller Home Price Index and the permanent volatility of NAREIT Equity Residential Index. The test result indicates that there is one-way Granger causality from the transitory volatility of S&P/Case-Shiller Home Price Index to the transitory volatility of NAREIT Equity Residential Index at 1% level of statistical significance.
Both NAREIT Equity Residential Index and S&P/Case-Shiller Home Price Index primarily reflect common real estate elements rather than idiosyncrasies. REIT prices reflect real estate market fundamentals.
In short, these results of this paper suggest that S&P/Case-Shiller Home Price Index volatility are closely related with NAREIT Equity Residential Index volatility. One series could be used to help predict the volatility on the other.
Unsecuritized real estate price volatility appears to play much of the role in forming REIT price volatility. The relationship between REIT price volatility and unsecuritized real estate price volatility may be of important implication regarding portfolio formation and volatility prediction not only to individual investors but also to institutional investors.