Tests of common real estate risk premia in a time-varying expected return framework

Abstract

Purpose - This paper aims to test the predictability of the three asset classes, namely direct property, bond and property stocks in Singapore. Design/methodology/approach - Using the generalized method of moment (GMM) estimation methodology, the authors first estimate the excess returns of assets on five instrumental variables and a constant term. Next the common risk factors are tested in three parts involving different portfolio of sample assets. Findings - The empirical results shows that there are at most three common risk factors that can be used to predict the excess returns of six asset classes, that include four direct property assets, bonds and property stocks. The results also indicate that there are separate common risk premia that are priced in property stock and direct property markets, which indirectly reject the hypothesis that the two property markets are integrated. Practical implications - The empirical results that reject the market integration between property and property stock markets imply that there are significant diversification benefits for holding both assets in investors' portfolios. The two property assets capture different risk premia in the markets. Research limitations/implications - The GMM specifications that include five instrumental variables may not fully capture all risk information. Omission of other variables is, however, traded-off against the parsimony of the model specification. More independent variables could be included in the future studies, and more asset classes could also be added to the tests. Originality/value - The study provides alternative evidence to the test of market integration between property and property stocks in Singapore. It also verifies the earlier study in the USA that property and stock market effects could be separately priced by the market.