using arbitrage pricing theory to analyse uk and usa property cycle differences
DESCRIPTION
Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences. European Real Estate Society Stockholm, Sweden June 2009 Terry V. Grissom Ph.D.* Jasmine L.C. Lim Ph.D.* James L. DeLisle Ph.D.** *School of the Built Environment University of Ulster, Jordanstown - PowerPoint PPT PresentationTRANSCRIPT
![Page 1: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/1.jpg)
Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle
Differences
European Real Estate SocietyStockholm, Sweden
June 2009Terry V. Grissom Ph.D.*Jasmine L.C. Lim Ph.D.*James L. DeLisle Ph.D.**
*School of the Built Environment University of Ulster, Jordanstown
**College of Built Environments University of Washington, Seattle
![Page 2: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/2.jpg)
• Investor concerns seeking potential timing market turnaround
• An Expectation is that an upturn in USA property/investment market will proceed an upturn in the UK: correlation analysis supports this position
• However analysis of historic property and economic cycles differences suggests alternative scenarios
• Expectation is not supported by lead-lag analysis
![Page 3: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/3.jpg)
Exhibit 2: Correlation of Property Returns in the UK and US and Systematic Factors
UK IPD
US NCREIF Returns
GDP:UK GDP:US Unanticipated Inflation: UK
Unanticipated Inflation: US
Term Structure: UK
Term Structure: US
Equity Risk Premium: UK
Equity Risk Premium: US
UK IPD Returns 1.000 US NCREIF Returns
0.269 1.000 GDP:UK 0.515 0.545 1.000 GDP:US 0.323 0.554 0.432 1.000 Unanticipated Inflation: UK
-0.403 -0.173 -0.424 -0.002 1.000 Unanticipated Inflation: US
-0.274 -0.073 -0.296 0.113 0.943 1.000 Term Structure: UK 0.206 0.112 0.291 -0.099 -0.920 -0.872 1.000 Term Structure: US 0.214 0.290 0.508 0.045 -0.893 -0.841 0.815 1.000 Equity Risk Premium: UK
0.291 0.252 0.336 0.243 -0.550 -0.471 0.503 0.495 1.000 Equity Risk Premium: US
0.238 0.236 0.334 0.142 -0.579 -0.507 0.523 0.547 0.395 1.000
![Page 4: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/4.jpg)
-.06
-.04
-.02
.00
.02
.04
.06
1980 1985 1990 1995 2000 2005 2010
UKGDP%
USAGDP%
UK Tre nd
USA Tre nd
Comparison of UK and USA GDP Percentage Change and Trends
9-11
![Page 5: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/5.jpg)
-.12
-.08
-.04
.00
.04
1990 1995 2000 2005
NCREIF
IPD UK
UK, IPD Returns and US NCREIF Returns: Monthly 1988-2009Total
Returns
Years
9-11
Exhibit 3
![Page 6: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/6.jpg)
-.04
-.02
.00
.02
.04
.06
1990 1995 2000 2005 2010
UK GDP Changes and IPD Return
%GDP
IPDLong-termTrend
Exhibit 4
![Page 7: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/7.jpg)
-.12
-.08
-.04
.00
.04
86 88 90 92 94 96 98 00 02 04 06 08 10
US GDP Change and NCREIF Returns
NCREIF
GDP%Long-termTrend
Exhibit 5
9-11
![Page 8: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/8.jpg)
• The differences in pricing/performance of cross markets in time suggest the arbitrage potential that may not support an equilibrium clearance of differences.
• This suggest a limited integration and possible segmentation of the two property/equity markets associated with divergent regimes due to differences in economic fluctuations.
• This suggests the use of an APT macroeconomic variable model to address differences in the cyclical patterns observed.
• The DCF construct of the APT model suggest pricing differences associated with behavioural differences observed in the two markets.
![Page 9: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/9.jpg)
• One test of a behavioural pricing differences is noted by Hendershott and MacGreger (2005)
• They note that investment behaviour difference between UK and USA property markets based on mean/trend reversion behaviour. Where:
–UK is rational reflecting trend reversion pricing
–USA is non-rational with no trend reversion pricing noted
![Page 10: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/10.jpg)
• The implication that differences in investor behaviour may contribute to pricing and timing differences defining the two markets fits the construct of the MVM Arbitrage Price Models
• This achieved using a spline analytic for cycle regime delineation as employed by Grissom & DeLisle (1999). This variable assist in identifying the potential timing and turnarounds observed and expected for both the UK and USA property markets.
• The theoretical constructs and the procedural steps employed in this analysis is illustrated in the following set of equations
![Page 11: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/11.jpg)
• URRE UFit )(
Where: FR = risk free rate (LIBOR)
= percentage change in GDP U = unanticipated inflation = term structure of interest rate = equity asset risk premium
![Page 12: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/12.jpg)
APT (US) with Expected risk free rate
R2 = 75.97%
Intercept & Beta
t statistic
(0.070599) + 1.209816 () - 1.221854(U) + 0.188532() + 0.079061() + i
-2.034205 5.205751 -12.13241 1.529515 2.439929 0.021155
APT (US) with Expected Zero Beta
R2 = 75.97%
Intercept & Beta
t statistic
-0.008317 + 1.209816 () - 1.221854(U) + 0.188532() + 0.079061() + i
-2.034205 5.205751 -12.13241 1.529515 2.439929 0.021155
URRE UFit )(
URRE UZit )(
![Page 13: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/13.jpg)
APT (UK) with Expected risk free rate
R2 = 93.28%
Intercept & Beta
t statistic
(0.070599) + 0.347208() - 0.868562(U) + 0.108614() + 0.035194() + i
-1.769832 7.920781 - 17.14555 2.317567 2.576084 0.019971
APT () with Expected Zero Beta
R2 = 93.28%
Intercept & Beta
t statistic
-0.003927 + 0.347208() - 0.868562(U) + 0.108614() + 0.035194() + i
-1.769832 7.920781 -17.14555 2.317567 2.576084 0.019971
iURRE UFit )(
iURRE UZit )(
![Page 14: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/14.jpg)
APT (UK) with Expected risk free rate and US Property Performance
R2 = 65.66
Intercept & Beta
t statistic
APT (UK) with Expected Zero Beta reflecting US Property Performance
R2 = 65.66
Intercept & Beta
t statistic
0.022861 + -0.199716() - 1.101734(U) + 0.021012() +
0.029849() +0.244874Rit|US
1.897037 -0.652772 -4.355030 0.164764 0.564750
2.099157
iRURRE USitRUUFit | )(
(0.070599) -0.199716() - 1.101734(U) + 0.021012() +
0.029849() +0.244874Rit|US
1.897037 -0.652772 - 4.355030 0.164764 0.564750 2.099157
iRURRE USitRUUZit | )(
![Page 15: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/15.jpg)
UK Returns as a function US MVM factors
iUSAitRUUSAUSAUSAUSA
USAUSAUUSAUSAFUKit
R
URRE
||||
|||| )(
iUSAitRUUSAUSA
USAUSAUSAUSAUUSAUSAZUKit
R
URRE
|||
||||| )(
![Page 16: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/16.jpg)
APT (UK) with Expected risk free rate and US Property Performance R2 = 60.29
Intercept & Beta
t statistic
(0.070599) -0.151844(|US) -0.333261(U|US)+0.454337(|US)+0.065742(|US) + 0.191620Rit|US
-3.129379 -0.357658 -2.086653 1.122048 1.217944 1.309247
APT (UK) with Expected Zero Beta reflecting US Property Performance R2 = 60.29
Intercept & Beta
t statistic
-0.023468 -0.151844(|US) -0.333261(U|US) +0.454337(|US) +0.065742() + 0.191620Rit|US
-3.129379 -0.357658 -2.086653 1.122048 1.217944 1.309247
iUSAitRUUSAUSAUSAUSAUSAUSAUUSAUSAFUKit RURRE |||||||| )(
iUSAitRUUSAUSAUSAUSAUSAUSAUUSAUSAZUKit RURRE |||||||| )(
![Page 17: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/17.jpg)
URRE UFit )( + knotE(Rit|)
Recessionary Spline
KnotE(Rit|)
coefficient
t-Statistic R2 -value
UK
1988-91 2.0958 5.5915 97.95 0.0000
1994-95 -19.1563 -1.6583 88.91 0.1358
1998-99 2.3055 1.1847 40.31 0.2738
2001-02 0.9952 31.8677 98.70 0.0000
2007-09 3.7072 1.2936 51.83 0.9465
US
1990-91 1.4878 5.6030 86.07 0.0000
2001-02 3.6434 6.0746 80.45 0.0000
2007-09 0.3499 1.1229 75.62 0.2818
![Page 18: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/18.jpg)
Conclusions
• The UK Property investment market is at best is only moderately integrated with the US property and capital markets suggesting the potential for similar pricing activities.
• However cycle investigation shows a difference in lead lag associations across markets.
• This suggest the possibility of arbitrage across markets and time.
• The application of the APT model shows that an integration of the US property returns and general economic factors however reduce the explanatory effect of MVM factors.
![Page 19: Using Arbitrage Pricing Theory To Analyse UK and USA Property Cycle Differences](https://reader035.vdocuments.net/reader035/viewer/2022070400/5681353a550346895d9c9e3b/html5/thumbnails/19.jpg)
Conclusions
•This suggested a difference in pricing behaviour across the 2 markets.
•One previously hypothesized reason is that the two markets reflect pricing differentials as a function of mean/trend reversion behaviour, suggesting that the UK more rationally prices general economic variables, while the US shows a decoupling of financial and real economic variables in the estimation of property returns