Option Market-Based Predictors of REIT Leverage Changes

28 Pages Posted: 15 Mar 2015 Last revised: 2 Jun 2016

See all articles by Paul Borochin

Paul Borochin

University of Miami

John L. Glascock

University of Connecticut - School of Business - Center for Real Estate and Urban Economic Studies; European Business School

Ran Lu-Andrews

California Lutheran University, School of Management

Jie Yang

Board of Governors of the Federal Reserve System

Date Written: March 12, 2015

Abstract

We create market-based measures from options data to predict changes in REIT capital structure. REIT capital structure differs from that of typical listed firms: REITs have high leverage ratios of about 50 percent, their use of short-term debt is higher and more volatile, and debt issuance and reduction are much higher and more volatile than the typical Compustat universe. Given that REITs have high leverage and a volatile capital structure, predicting REIT capital structure change should be valuable. We do so using market-based measures which update at higher frequency than traditional accounting characteristics.

Realized volatility and forward-looking risk expectations from option prices are significant predictors of both debt and equity issuance in REITs. Realized volatility is also a significant predictor of net changes in REIT leverage. Consistent with Borochin and Yang (2015), we find that REITs with higher historical volatility or fewer option contracts are less likely to increase leverage in the following quarter. Increases in the perception of REIT equity risk, measured by the spread between implied and realized volatilities, are negatively associated with equity issuance. The spread between call and put volatilities, a measure of expected REIT performance, is correlated with future debt issuance. Our explanation for these behaviors is that REIT managers use market information about risk as an input into their capital structure decisions.

Keywords: Capital Structure, Real Estate, REITs, Options, Implied Volatility

JEL Classification: R33, G32, G12, G14

Suggested Citation

Borochin, Paul and Glascock, John L. and Lu-Andrews, Ran and Yang, Jie, Option Market-Based Predictors of REIT Leverage Changes (March 12, 2015). Journal of Real Estate Finance and Economics, Forthcoming; Georgetown McDonough School of Business Research Paper No. 2577414. Available at SSRN: https://ssrn.com/abstract=2577414 or http://dx.doi.org/10.2139/ssrn.2577414

Paul Borochin (Contact Author)

University of Miami ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States

John L. Glascock

University of Connecticut - School of Business - Center for Real Estate and Urban Economic Studies ( email )

Storrs, CT 06269
United States

European Business School ( email )

Gustav-Stresemann-Ring 3
Wiesbaden, Hessen 65189
Germany

Ran Lu-Andrews

California Lutheran University, School of Management ( email )

60 W. Olsen Road
School of Management
Thousand Oaks, CA California 91360
United States

Jie Yang

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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