The Relationships between Real Estate Price and Expected Financial Asset Risk and Return: Theory and Empirical Evidence

38 Pages Posted: 20 Mar 2013 Last revised: 23 Jul 2013

See all articles by Gang-Zhi Fan

Gang-Zhi Fan

School of Management, Guangzhou University

Zsuzsa R. Huszar

National University of Singapore ; Central European University

Weina Zhang

Department of Finance, National University of Singapore; National University of Singapore Risk Management Institute

Date Written: May 19, 2012

Abstract

In pricing real estate with indifference pricing approach, market incompleteness is shown to significantly alter the conventional pricing relationships between real estate and financial asset. Specifically, we focus on the pricing implication of market comovement because comovement tends to be stronger in financial crisis when investors are especially sensitive to price declines. We find that real estate price increases with expected financial asset return but only in weak market comovement (i.e., a normal market environment) when investors enjoy diversification benefit. When market comovement is strong, real estate price strictly declines with expected financial asset return. More importantly, contrary to the conventional positive relationship from real option studies, real estate price generally declines with expected financial asset risk. With realistic market parameters, we show that there is a nonlinear relationship between real estate price and financial risk. When the market comovement is strong, real estate price only increases with financial asset risk when the risk is low but eventually declines with the risk when it becomes high. Our cross-country empirical results also show that the relationship between financial market risk and real estate price is non-monotonic, conditional on the degree of market comovement.

Keywords: comovement, indifference pricing, incomplete market, real estate, risk and return

JEL Classification: G1, G12

Suggested Citation

Fan, Gang-Zhi and Huszar, Zsuzsa R. and Zhang, Weina, The Relationships between Real Estate Price and Expected Financial Asset Risk and Return: Theory and Empirical Evidence (May 19, 2012). Journal of Real Estate Finance and Economics, Vol. 46, No. 4, 2013, Available at SSRN: https://ssrn.com/abstract=2235698

Gang-Zhi Fan

School of Management, Guangzhou University ( email )

230 Wai Huan Xi Road
Guangzhou Higher Education Mega Center
Guangzhou, Guangdong 510006
China

Zsuzsa R. Huszar

National University of Singapore ( email )

Business School
15 Kent Ridge Drive
Singapore, 117592
Singapore
+65 6516 8017 (Phone)
+65 6779 2083 (Fax)

Central European University ( email )

Nador utca 9
Budapest, H-1051
Hungary

Weina Zhang (Contact Author)

Department of Finance, National University of Singapore ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore
65168120 (Phone)
67792083 (Fax)

HOME PAGE: http://bizfaculty.nus.edu/faculty-profiles/108-weina

National University of Singapore Risk Management Institute ( email )

21 Heng Mui Keng Terrace
Level 4
Singapore, 119613
Singapore

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