Forward Curve Risk Factors Analysis in the UK Real Estate Market

Abstract

This paper empirically investigates the risk factors of the property swap prices using four years of price data relative to the UK Investment Property Databank (IPD) Total Return All Property Swap. The implied forward rates are analyzed with a first difference model to determine its main components. Regarding the risk free rate, the traditional sport-forward relation does not hold for property derivatives. The impact of the risk free rate on forward rates appears as being complex and made of different effects; it varies according to time and maturities. Derivatives prices take into account the smoothing effect of the underlying index and REITs stock are also relevant to explain these prices. The informational content of the swap is important. The impact of the REITs and of the smoothing decreases with maturities. The risk factor structure obtained is more complex than found in many other studies relative to commodities, securities or bonds. Possible reasons for this phenomenon are discussed.

Keywords: Real estate swap; Forward curve; Apprasial based index; First-difference model