Dynamic Correlations Among Classes: REIT and Stock Returns

Posted: 22 Feb 2012

See all articles by Brad Case

Brad Case

Fannie Mae

Yawei Yang

affiliation not provided to SSRN

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York

Date Written: February 22, 2012

Abstract

We use the Dynamic Conditional Correlation model with Generalized Autoregressive Conditional Heteroskedasticity (DCC-GARCH) developed by Engle (2002) to examine dynamics in the correlation of returns between publicly traded REITs and non-REIT stocks. The results suggest that REIT-stock correlations form three distinct periods. During the first period, ending in August 1991 with the start of the modern REIT era, correlations were high and without trend, never dipping below 59%. During the second period, ending in September 1991 with the inclusion of REITs in broad stock market indexes, correlations declined precipitously to 30%, enabling substantially higher portfolio allocations to both high-return asset classes and therefore higher portfolio returns without increasing portfolio volatility. During the third period, since September 1991, correlations increased steadily but only reached 59% in late 2008. A simple portfolio optimization suggests that asset managers would be willing to pay 20 basis points per year, plus the difference in transaction costs, for the ability to use DCC-GARCH modeling of dynamic correlations in place of rolling 24-month asset correlations.

Keywords: DCC-GARCH, REITs, Volatility, Portfolio optimization, Asset allocation

Suggested Citation

Case, Bradford and Yang, Yawei and Yildirim, Yildiray, Dynamic Correlations Among Classes: REIT and Stock Returns (February 22, 2012). Journal of Real Estate Finance and Economics, Vol. 44, No. 3, 2012. Available at SSRN: https://ssrn.com/abstract=2009540

Bradford Case (Contact Author)

Fannie Mae ( email )

3900 Wisconsin Avenue, NW
Washington, DC 20016-2892
United States
202-752-4221 (Phone)

Yawei Yang

affiliation not provided to SSRN ( email )

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York ( email )

55 Lexington Ave., Box B13-260
New York, NY 10010
United States

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