Can Linear Predictability Models Time Bull and Bear Real Estate Markets? Out-of-Sample Evidence from REIT Portfolios

Posted: 25 Jun 2014

See all articles by Massimo Guidolin

Massimo Guidolin

Bocconi University, Dept. of Finance; Bocconi University - CAREFIN - Centre for Applied Research in Finance

Daniele Bianchi

School of Economics and Finance, Queen Mary University of London

Multiple version iconThere are 2 versions of this paper

Date Written: June 18, 2014

Abstract

A recent literature has shown that REIT returns contain strong evidence of bull and bear dynamic regimes that may be best captured using nonlinear econometric models of the Markov switching type. In fact, REIT returns would display regime shifts that are more abrupt and persistent than in the case of other asset classes. In this paper we ask whether and how simple linear predictability models of the vector autoregressive (VAR) type may be extended to capture the bull and bear patterns typical of many asset classes, including REITs. We find that nonlinearities are so deep that it is impossible for a large family of VAR models to either produce similar portfolio weights or to yield realized, ex-post out-of-sample long-horizon portfolio performances that may compete with those typical of bull and bear models. A typical investor with intermediate risk aversion and a 5-year horizon ought to be ready to pay and annual fee of up to 5.7 percent to have access to forecasts of REIT returns that take their bull and bear dynamics into account instead of simpler, linear forecast.

Keywords: REIT returns; Predictability; Strategic asset allocation; Markov switching; Vector autoregressive models; Out-of-sample performance

JEL Classification: G11, C53

Suggested Citation

Guidolin, Massimo and Bianchi, Daniele, Can Linear Predictability Models Time Bull and Bear Real Estate Markets? Out-of-Sample Evidence from REIT Portfolios (June 18, 2014). Journal of Real Estate Finance and Economics, Vol. 49, No. 1, 2014, WBS Finance Group Research Paper No. 221, Available at SSRN: https://ssrn.com/abstract=2456275

Massimo Guidolin (Contact Author)

Bocconi University, Dept. of Finance ( email )

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Bocconi University - CAREFIN - Centre for Applied Research in Finance

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Daniele Bianchi

School of Economics and Finance, Queen Mary University of London ( email )

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United Kingdom

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