INTEREST RATES SENSITIVITY & PROPERTY STOCKS RISK PREMIUM: AN INTERNATIONAL STUDY. A GARCH-M MODEL

Abstract

In light of the current changing financial market environment, this dissertation aims to investigate the dynamic between interest rate and risk premium of three major Asian and two Western property markets within a time-varying risk framework. Additionally, this dissertation also aims to investigate the effects of leverage at firm level on interest rate sensitivity for property stocks. The generalized autoregressive conditionally heteroscedasticity in the mean (GARCH-M) model is identified as a suitable model for the investigation of the aforementioned dynamics. Subsequently, it is expanded into a three-factor model with risk premium volatility, change in interest rate and interest rate volatility as factors. Analysis are undertaken on weekly risk premium derived from property stock indexes for the period January 1990 – May 2016. Property stocks risk premium are sensitive to interest rate changes and interest rate volatility, especially to the long-term interest rate (5-years). Overall, there are disparities in the magnitude as well as direction of sensitivities in interest rates level and volatility across the five listed property markets. Findings indicate that volatility persistence generally increased post Global Financial Crisis (2007), with Singapore and United Kingdom market consistently displaying the highest and lowest volatility persistency respectively. The increase in interest rates sensitivity post-2007 occurs in most cases. However, the changes are not uniform and depend on the individual listed property markets. Overall, property stocks risk premium is found not to be sensitive to its own volatility. The effect of leverage to property stocks risk premium are found to be both time-varying and market-dependent. Other factors that could affect interest rate sensitivity could be the local institutional framework, financial market regulation and individual firm’s use of funds. The findings serve to enhance on the existing literature regarding the dynamics between interest rate and property stocks. With increased understanding, this could aid in portfolio management and investors’ decision making processes. Such knowledge could also help policy makers in regulating the market to ensure a sustainable environment. Firms could also make use of this findings to adjust their leverage accordingly to lower their stocks exposure to interest rates.