Correlation and Volatility Dynamics in REIT Returns: Performance and Portfolio Considerations

Abstract

In this article, the authors examine the dynamics of the correlation and volatility of REITs, stocks, and direct real estate returns using monthly data from January 1987 to May 2008. In order to explore asymmetries in conditional correlation, the authors use a multivariate asymmetric dynamic diagonal conditional correlation (AD-DCC) GARCH specification. They document that the time-varying conditional correlations can be explained by macroeconomic variables, such as term and credit spreads, inflation, and the unemployment rate, and they find a strong relationship between correlations and REIT returns and that the patterns are distinguishable for different types of REITs. Interestingly, when the correlation between REITs and the S&P 500 is at its lowest, the future performance of REITs is at its highest. For equity REITs, a robust relationship exists between correlations and future returns; that is, the higher (lower) correlation between equity REITs and direct real estate, the higher (lower) the future returns of equity REITs. The authors’ results have economic implications regarding the time-dependent diversification benefits of REITs in a mixed-asset portfolio and the unique risk and return characteristics of REITs.