EXAMINING THE MARKET EFFICIENCY OF S-REITS THROUGH BINOMIAL OPTION PRICING

Abstract

This study looks at risk-neutral and non-risk-neutral pricing of Singapore real estate investment trusts (S-REITs) via comparing the average of the individual (Deviation between expected and observed closing price/Observed closing price) ratios with the (Standard Deviation/Mean) ratio of the closing prices themselves, with the help of the Binomial Options Pricing model. If the (Standard Deviation/Mean) ratio is greater than or equal to the (Deviation between expected and observed closing price/Observed closing price) ratio, then the deviation of closing prices from the expected risk-neutral prices is not significant and the S-REIT is consistent with risk-neutral pricing. If the (Deviation between expected and observed closing price/Observed closing price) ratio is greater, then the S-REIT is not consistent with risk-neutral pricing. Capitacommercial Trust, Capitamall Trust and Keppel REIT have large positive differences between the two ratios (39.86%, 30.79% and 18.96% respectively), implying that these S-REITs are not trading at risk- neutral pricing. Suntec REIT has a small positive difference of 2.35% between both ratios, implying that it is trading at risk-neutral pricing. Ascendas REIT has the largest negative difference between the two ratios at -4.24%, followed by Mapletree Logistics Trust at -0.44%. It is discerned that both these S- REITs are trading at risk-neutral pricing. Further analysis of the average of (o- e) values show that Capitacommercial Trust, Capitamall Trust and Keppel REIT exhibit risk-averse pricing. Results are consistent with prudential asset allocation for viable S-REIT portfolio investing but not all these S-REITs exhibit strong market efficiency in their pricing. Pricing may be risk-neutral over a certain period but investor or market sentiments, the fear of risks and speculative activities could still affect an S-REIT’s risk neutrality. With enhanced risk diversification measures, it should be possible for S-REITs to achieve risk-neutral pricing. It boils down to the amount of risk exposure and how much confidence investors have in the S-REIT portfolio and returns.