Time-Varying Systematic Illiquidity and Mispricing in Reits

Abstract

This dissertation provides a new way to explain mispricing in REITs from the perspective of illiquidity. I hypothesize that REITs? illiquidity prevents informed traders fully utilize the private price information and prevents them arbitrage against mispricing, leading to a persistent divergence between REIT?s transaction price and its fundamental value. Moreover, because the variation of REIT?s individual illiquidity moves closely with the market-wide illiquidity, mispricing in REITs can be explained by stock market illiquidity. The hypothesis is tested by looking at a panel of 174 REIT firms from January 1, 1993 to December 31, 2008. Using 2SLS models, I find that the lagged market-wide illiquidity can explain 14% of variation in REITs mispricing after controlling for size and value effects. I also find that the lagged market illiquidity has a stronger explanation power for mispricing when market return is declining, market volatility is high, and inflation rate is high. This result suggests that REITs face stronger illiquidity risk in down markets than in up markets, thus investors who are interested in REITs as a diversification tool should consider the attributes of REITs liquidity in up and down markets