Contagion and the real estate markets of the Pacific Rim countries

Abstract

Restricted Item. Print thesis available in the University of Auckland Library or may be available through Inter-Library Loan. The benefits of international diversification within real estate portfolios rely on the correlation among the subject markets. If a contagion effect exists in these markets, the benefits arising from international diversification of real estate investment would be diminished due to the higher correlation caused by a contagion effect. Therefore, it is very important in understanding the nature and performance of international real estate portfolios to examine the existence of a contagion effect among international real estate markets. Specifically, this study defines contagion as significant co-movement of real estate markets beyond systematic risks that can be explained by economic fundamentals. With this definition, this study examines the co-movement of real estate returns among the Pacific Rim countries after controlling for the effect of economic fundamentals during four recent financial crises (the Mexican, Asian, Russian and Brazilian crises). It also attempts to characterise the form of contagion, investigating whether the contagion effects are symmetric between the real estate markets of the Pacific Rim counties. The test results show that the phenomenon of contagion existed in the real estate markets of the Pacific Rim countries even though the contagion effect did not exist in all of the cases during the recent financial crises. Furthermore, after controlling for the effect of the economic fundamentals there was always a significant contagion effect between Honk Kong and Japan, Hong Kong and Singapore, and Japan and New Zealand. They also show that there is a significant evidence of contagion at the 5% level between Australia and New Zealand for all the financial crises except for the Brazilian crisis. This result indicates that it is difficult for international investors to diversify effectively in these real estate markets during a financial crisis. In contrast, there was an absence of a significant contagion effect, at the 5% level, after controlling for the effect of the economic fundamentals in only four cross country relations (between Canada and Indonesia, Indonesia and New Zealand, Indonesia and Singapore, and between Singapore and the USA) out of 78 combinations of cross country relations between the real estate markets in the Pacific Rim area during the four financial crises. In conclusion, substantial diversification benefits from investing in the real estate markets of the Pacific Rim countries may be available to international investors only in a limited number of countries. In addition, the test results from Granger Causality analysis show that the contagion effects between the real estate markets of the Pacific Rim countries were usually asymmetric. There were significant bi-directional relationships at the 5% level in only 5.9% of the total cases where contagion effects existed between the real estate markets of the Pacific Rim countries during the four financial crises. Another major purpose of this study is to examine what types of real estate companies are most affected by a financial crisis and to find out which transmission channels of a crisis are more important in the real estate markets of the countries. Specifically, this study used a risk adjustment model for each of the subject real estate companies and calculated cumulative abnormal returns for each company during each financial crisis. These cumulative abnormal returns were utilised as dependent variable in the regression model including important firm characteristics such as firm size, profitability, dividend yield, gearing risk, liquidity, growth, property investment and regional location. The test results show that the null hypothesis (that is a financial crisis has no impact on the returns of the real estate companies in the Pacific Rim area) was rejected significantly at the 1% level for all financial crises. The results also suggest that gearing risk was the most significant firm characteristic in determining the impact on the returns of the real estate companies during four recent financial crises. These results support that a credit crunch was the most important channel of a crisis in the real estate markets of the Pacific Rim countries during the recent financial crises. Profitability, liquidity, growth opportunity, dividend yield properly investment, regional location and firm size were statistically significant firm characteristics on a case by case basis. Although several studies of contagion have been conducted using aggregated macroeconomic data, this research is the first to explain contagion effects among the real estate markets in the Pacific Rim area by using firm level information as well as macro level data. The research results will be helpful for international investors to understand the nature and performance of international properly investment during a financial crisis.