Hedging Housing Risk*

An unusually rich source of data on housing prices in Stockholm is used to analyze the investment implications of housing choices. This empirical analysis derives market-wide price and return series for housing investment during a 13-year period, and it also provides estimates of the individual-specific, idiosyncratic, variation in housing returns. Because the idiosyncratic component follows an autocorrelated process, the analysis of portfolio choice is dependent upon the holding period. We analyze the composition of household investment portfolios containing housing, common stocks, stocks in real estate holding companies, bonds, and t-bills. For short holding periods, the efficient portfolio contains essentially no housing. For longer periods, low-risk portfolios contain 15 to 50 percent housing. These results suggest that there are large potential gains from policies or institutions that would permit households to hedge their lumpy investments in housing. We estimate the potential value of hedges in reducing risk to households, yet yielding the same investment returns. The value is surprisingly large, especially to poorer homeowners.     

Ex post: The investment performance of collectible stamps

This paper uses stamp catalogue prices to investigate the returns on British collectible postage stamps over the period 1900–2008. We find an annualized return on stamps of 7.0% in nominal terms, or 2.9% in real terms. These returns are higher than those on bonds but below those on equities. The volatility of stamp prices approaches that of equities. Stamp returns are impacted by movements in the equity market, but the systematic risk of stamps remains low. Stamps partially hedge against unanticipated inflation. Estimates of average after-cost returns for individual investors show that stamps may rival equities in terms of realized performance.     

Are TIPS the “real” deal?: A conditional assessment of their role in a nominal portfolio

This paper documents predictable time-variation in the real return beta of US Treasury Inflation Protected Securities (TIPS) and in the Sharpe ratios of both indexed and conventional bonds. The conditional mean and volatility of both bonds and their conditional correlation first are estimated from predetermined variables. These estimates then are used to compute conditional real return betas and Sharpe ratios. The time-variation in real return betas and the correlation between TIPS and nominal bonds coincides with major developments in the fixed-income market. One implication of this predictability is that portfolio managers can assess more efficiently the risk of investing in TIPS versus conventional bonds. Conditional Sharpe ratios indicate that over the sample period, TIPS had superior volatility-adjusted returns relative to nominal bonds. This finding is striking in view of the absence of a major inflation scare during the sample period from February 1997 through August 2001, but is loosely consistent with the possibility that TIPS elevated rather than reduced Treasury borrowing costs. On the other hand, mean–variance spanning tests indicate that TIPS did not enhance the mean–variance efficiency of diversified portfolios.     

The impact of delivery terms on stock return volatility

The application of generalized ARCH models to daily stock returns shows changes in delivery and payment terms to be an important factor in determining measured volatility. In contrast, the holding period between trading days when markets are closed is relatively unimportant. This new approach allows fresh insights into stock return volatility and indicates that subsequent research on stock return volatility should incorporate the effects of payment delays.     

Market States and the Effect on Equity REIT Returns due to Changes in Monetary Policy Stance

This study investigates the effect of changes in monetary policy on US equity real estate investment trust (EREIT) returns in lower and higher return ranges during bull, bear, and volatile stock market states using quantile regression. Results show that EREIT returns are sensitive to changes in monetary policy at different EREIT return ranges in different market states. During bull markets, changes in monetary policy have a significant negative impact on EREIT when investors have lower expectations of real estate price increases, but are not effective when investors have higher expectations of real estate price increases. During volatile and bear markets, EREIT returns are not sensitive to changes in monetary policy stance. Results also show that EREIT returns respond positively to stock returns in various states and conditions.     

The Short-Term Inflation-Hedging Characteristics of U.K. Real Estate

This study investigates the short-term inflation-hedging characteristics of U.K. real estate compared to other U.K. investments. It considers not only total returns but also changes in income and changes in capital values. The analyses are undertaken using annual and quarterly data. Stocks, bonds, appraisal-based real estate (including the three property types, separately), and real estate stocks are considered. Real estate series, constructed from the original appraisal series to take account of autocorrelation, also are used. The methodology is based on that devised by Fama and Schwert (1977) and tests are undertaken for stationarity and structural breaks. Hypotheses are established about the coefficients on expected and unexpected inflation in the model, and these are tested. It is concluded that real estate has poorer short-term hedging characteristics for total return, change in capital value, and change in income than stocks but better characteristics than bonds. However, there is evidence to suggest that the relationships change under different economic environments.     

Reversal of 3‐day losers and continuation of 3‐day winners on the NASDAQ

Using only the 200 large-cap securities that make up the NYSE 100 and NASDAQ 100, this study investigates 130 randomly selected formation periods from January 2000 through December 2012. During these formation periods, the three worst and three best performing stocks (based on excess return) are flagged. Once flagged, the subsequent 10-day holding period excess returns are calculated. Results indicate that NYSE securities demonstrate significant return reversal, but not return momentum. Conversely, the worst performing NASDAQ securities demonstrate return reversal, whereas the best performing NASDAQ securities demonstrate return momentum. Results are robust to the number of best and worst stocks that are flagged. Results are also robust to other combinations of formation and holding period lengths.     

The unsung impact of currency risk on the performance of international real property investment

The paper revisits the currency risk debate to ascertain the statistical significance of currency risk on the return of international real property investment, especially in a period of increased exchange rate volatility. After statistical analyses of the returns of a portfolio of office investments in seven Asia Pacific cities over the 1986 to 2007 period, it was found that currency risk had a statistically significant positive impact on the performance of the portfolio of office investments. This is confirmed by the results of stochastic dominance test. If the results of this study are verified by subsequent studies, and the past reliably presages the future, they would imply that investors holding portfolios of real property investments in the sample markets might not need to be unduly concerned with currency risk.     

Evidence on the Extent and Potential Sources of Long Memory in U.S. Treasury Security Returns and Yields

Unlike equity returns, many fixed-income return measures appear to display long memory. We show that the extent of long memory differs strongly for gross and excess holding period returns on U.S. Treasury securities. Granger and others have argued that long memory may only reflect infrequent structural breaks. We explore the impact of structural instability on tests for long memory and find only weak indications that it lies behind the long memory in our return series. The evidence of long memory remains strong for yield and term premia series even after accounting for a series of potential underlying structural changes.     

Accounting‐Based Probabilistic Prediction of ROE,the Residual Income Valuation Model and the Assessment of Mispricing in the Swedish Stock Market

Using Swedish stock market data, this study investigates whether an investment strategy based on publicly available accounting information can generate abnormal investment returns. The strategy involves two steps. First, an accounting‐based probabilistic prediction model of changes in the medium‐term book return on owners' equity (ROE) is estimated. Second, market expectations of changes in medium‐term ROE are assessed through observed stock prices and the residual income valuation model. Stock market positions over 36‐month holding periods are taken when the accounting‐based predictions of ROE and the market expectations differ. Over the period 1983–2003, the investment strategy generated values of Jensen's alpha corresponding to an average monthly excess return for a hedge position of up to 0.8% for a sample of manufacturing companies. In the main this hedge return was caused by strong positive returns to the long positions, and additional analyses show that the returns appear to have been affected by a positive market sentiment bias (i.e., positive ROE surprises being associated with stronger price reactions than negative ROE surprises) making out‐of‐sample inferences somewhat dubious. Furthermore, most of the investment returns accrued over holding periods up to around 1995, with no indications of market mispricing over the last third (1995–2003) of the investment period. The empirical results are consistent with market investors having become more sophisticated in their use of publicly available accounting information over time.     

The Impact of Option Introduction on Stock Return Variances: The Role of Bid-Ask Spreads, Return Autocorrelations, and Intrinsic Variances

The purpose of this paper is to examine changes in stock return variances following option introduction. The sample consists of National Market System stocks and employs both transaction returns and returns based on bid and ask quotes. Variances are decomposed into portions attributable to bid-ask spreads, return autocorrelations, and intrinsic variances. Spreads play a negligible role in explaining variance changes. A generally positive component to short-term autocorrelations falls following option introduction, increasing variances over short holding periods. Intrinsic variances fall prior to the October 1987 crash, but do not change after the crash with option introduction.     

Monetary policy surprises and international bond markets

We examine the impact and spillover effects of monetary policy surprises on international bond returns. Within the framework of Campbell and Ammer (1993), we decompose international bond returns into news regarding future returns, real interest rates and future inflation for Germany, the U.K. and the U.S. We examine how excess bond returns in these three countries are affected by surprise changes in monetary policy in each country. Our measure of the unanticipated element of monetary policy is based on futures markets rather than the more traditional vector autoregression. Our results indicate that excess bond returns primarily react to domestic as compared to foreign monetary policy surprises. We also find there is a strong divergence between the effects of domestic monetary policy on excess bond returns in Germany relative to the U.K. A surprise monetary tightening in Germany (U.K.) leads to a rise (fall) in the excess holding period return. We trace this effect to news about lower (higher) inflation expectations and could be potentially rationalized by differences in the credibility of the monetary policy authority in each country.     

Changes in volatility of credit spread and market efficiency during rapid growth of credit-related securities

This paper investigates the changes in credit spread volatility during 1993–2001. We find that the credit spreads between junk-grade corporate bonds and Treasury bonds were significantly more volatile in the second half of this period when credit-related securities became popular. In contrast, investment-grade bonds exhibited no significant change in volatility. The junk bonds variance ratios changed from being less than one to greater than one. Using the GJR-Garch model, the conditional volatilities of junk bonds increased in the second half of the period and the mean reversion speeds slowed, suggesting a longer time for mean reversion to occur. Our analysis rules out treasury volatility, credit spread level, equity market return, T-bill rate, curvature of the Treasury curve, financial crisis, quantity of defaults and standard deviation of defaults as explanations for the increase in junk bond volatility. In contrast, volatility of equity returns provides a partial explanation of junk bond spread volatility in the later period.     

Time-varying risk and return in the bond market: a test of a new equilibrium pricing model

This article uses bond market data to empirically test the assetpricing model of Kazemi (1992). According to this model therate of return on a long-term, pure-discount, default-free bondwill be perfectly correlated with changes in the marginal utilityof the representative investor. The covariability between financialasset returns and returns on such a bond can therefore serveas a measure of the riskiness of assets. The aim of this studyis to determine whether the model can explain cross-sectionaldifferences in the monthly returns of bonds with different maturitydates. We estimate and test the restrictions imposed by themodel on returns of default-free bonds, while allowing the conditionaldistribution of bond returns to be time varying. The model isrejected during the full sample period (1973-1995) and the subperiod(1973-1980) when the Federal Reserve's focus is on interestrates, while the model is not rejected during the subperiod(1981-1995) when the Federal Reserve's focus is on money supply.     

The determinants of the return on index bonds

The investor holding an index-linked bond is guaranteed a given real income irrespective of the prevailing inflation rate. The holding-period return (HPR) on such a bond should, therefore adjust to realized inflation; this is the firsthypothesis tested. The value of the bond may also change due to anticipated changes in the real interest rate which should themselves be related to uncertainty about future inflation; hence HPRs on linked bonds may vary with inflation uncertainty (second hypothesis). Furthermore, for bonds with long periods of time to maturity the effect of uncertainty about future inflation rates may be rather small so that as we approach maturity, the effect of inflation uncertainty should increase (third hypothesis). These three hypotheses are tested on a sample of eight Israeli index-linked bonds with maturities three months apart. The first hypothesis is supported by the data but the last two are not.     

Owner-occupied homes,income-producing properties,and REITs as inflation hedges: Empirical findings

New evidence on the correlation patterns of various real estate returns with inflation is presented. Returns on a wide array of real estate, nonresidential as well as residential, are investigated. Stock and bond returns are also analyzed for comparison purposes. Extensive heterogeneity is found in real estate return correlations with inflation. Nonresidential property returns are most strongly positively correlated with inflation, although the appreciation in owner-occupied homes is also positively associated with inflation. However, REIT returns tend to be strongly negatively correlated with inflation. In this respect, they look more like traditional stocks and bonds than any other type of real estate. Finally, new evidence on return correlations with energy prices is also presented. Nonresidential real estate performs best here, too, although no real estate asset fully compensates investors for adverse energy price shocks.     

Market reaction to the formation of one-bank holding companies

This study examines the question of whether or not the formation of one-bank holding companies is of such importance as to materially affect the return generating process for the associated common stock issues. As such this study attempts to provide the security analyst with answers as to how best to define the parameters of the distribution of firm returns, that is, which past observations are relevant to the firm's present return generating mechanism. The results of the tests performed indicate that the formation of a one-bank holding company generally does not have a significant impact on the return generating mechanism for the underlying stock of the affected bank. Thus, the market does not appear to attach any real significance to this particular shift in organizational form by the commercial banks studies.     

Is the Mean Return of Hotel Real Estate Stocks Apt to Overreact to Past Performance?

This study examines the return patterns of hotel real estate stocks in the U.S. during the period from 1990 to 2007.We find that the magnitude and persistence of future mean returns of hotel real estate stocks can be predicted based on past returns, past earnings surprise, trading volume, firm size, and holding period. The empirical evidence found from this paper confirms that short-horizon contrarian profits can be partially explained by the lead-lag effects, while in the intermediate-term price momentum profits and long-term contrarian profits can be partially attributed to the firms’ overreaction to past price changes. Our results support the contrarian/overreaction hypothesis, and they are inconsistent with the Fama-French risk-based hypothesis or the underreaction hypothesis. The study also confirms the earning underreaction hypothesis and finds the high volume stocks tend to earn high momentum profits in the intermediate-term. The study finds that the earning momentum effect for hotel stocks is more short-lived and smaller in magnitude than the market average. Price momentum portfolios (or contrarian portfolios) of big hotel firms underperform small hotel firms and the hotel price momentum portfolio (or contrarian portfolios) significantly underperform the overall market over the intermediate-term (or the long-term). These findings imply that the U.S. hotel industry, particularly the big hotel firms, have experienced relatively conservative growth in the sample period. It suggests that a conservative hotel growth strategy accompanied by an internal-oriented financing policy is proper in a period of prosperity.     

Personal Taxation and Investment Incentives in a Small Open Economy

A simple portfolio model is used to investigate the effects of personal taxes on real investment incentives in a small open economy with large and small firms. When shares in large firms can be traded internationally and their rate of return is exogenously determined on international equity markets, a tax on the return on riskless bonds will induce a portfolio shift from bonds to shares in large firms. This shift reduces the impact of the bond tax on the required rate of return on shares in domestically owned small firms, provided that returns on shares in small and large firms are positively correlated. The total impact of the bond tax may even change from a negative to a counter-intuitive positive one if the “beta” between the returns on small and large firms is above unity. A personal tax on equity returns does in general have an ambiguous impact on the pre-tax rate of return requirement of domestically owned firms. An exogenous rate of return on large company shares is shown to enhance the possibility for the equity tax to reduce the required pre-tax rate of return in small domestic firms. A sufficient condition for a negative relationship is again that the “beta” between the returns in small and large firms is above unity. This revised version was published online in July 2006 with corrections to the Cover Date.     

A Market-based Risk Classification of Financial Institutions

In this article we derive, estimate, and analyze a multifactor model of the monthly holding period returns on the stocks of exchange-traded financial institutions. In addition to bond and equity returns, the factors include default, liquidity, and term structure risk premiums plus variables that measure changes in deposit demand. To ensure that our sample has a large number of firms, we use data from January 1981 through December 1988. The equity return explains a large share of time-series variation in financial institutions' returns. The additional factors implied by theory have little incremental explanatory power. The two-factor model regression coefficients have considerable cross-sectional variation. This permits us to group intermediaries into portfolios with similar risk exposures. These portfolios bear no relation to the SIC codes that group intermediaries by their charters and lines of business.