THE RELATIONSHIP AMONG REITS, STOCK MARKET, AND MACROECONOMY : A VECTOR ERROR CORRECTION MODEL

Abstract

This paper investigates the relationships among real estate investment trusts (REITs), the stock market, real economic activity, and inflation in the United States using monthly data from September 2004 to May 2011. The empirical study is conducted via the Vector Error Correction model (VECM) coupled with Cointegration analyses. Cointegration tests are carried out to examine the long-run movement of REITs returns in response to the stock market, real economic activity, and inflation during the investigation period. An error correction model is estimated to capture the short-run deviations of the variables from the long-run equilibrium relationship. The empirical results show that REITs are effective inflation hedges in the longrun, but relationship between REITs and inflation is insignificant in the short-run. Moreover, no cointegrating relationship is detected between REITs and the stock market, which provides implication on the portfolio diversification potential between these two asset classes. Another important finding is the significant impact of real economic activity on REITs returns. REITs returns are found positively correlated to the changes in the industrial production, both in the long- and short-run. This implies that when economy performs well, the REITs also do well in terms of returns. The results are important for investors and policy makers. For investors, they are able to hedge against inflation by investing in REITs over a longer holding period. In addition, the finding of no integration between REITs and the stock market suggests that there may be profitable reallocation of portfolio within these two asset classes. Lastly, for policy makers, close monitoring of economic condition and prudent implementation of economic policies are crucial, as changes in economic performance will be reflected in REITs pricings.