A range-based volatility approach to measuring volatility contagion in securitized real estate markets

a r t i c l e i n f o Keywords: Price range CARR Financial crisis Smooth transition copula Volatility contagion REIT We use a newly-developed time-varying range-based volatility model to capture the dynamics of securi-tized real estate volatility. The novelty of the model is the use of a smooth transition copula function to capture the nonlinear comovements between major REIT markets in the presence of structural changes. We then investigate the impact of extreme events on the volatility dependence in a broad set of 13 developed countries over the period from 1990 to 2012. We find that information transmission through the volatility channel can exhibit either bi-or uni-directional causality. In addition, financial contagion following the subprime crisis is found between the U.S. and Australia. The benefits of diversification, especially between multiple asset classes with varying degrees of correlation, have long been a widely accepted by finance practitioners and academics. However, recent experience during the market crises of the late 2000s has shown that diversification may not always produce the benefits promised. Therefore , a better understanding of the dynamics of the correlation between asset markets is important for asset pricing, portfolio allocation, and risk management. For example, the comovement between asset returns is likely to change over time, thus creating a need to dynamically update portfolio allocations to improve investment strategies. However, the cross-market linkage is not necessarily through the return channel, as volatility may always link markets. In particular, the literature has found that the spreading of shocks from one market to another can cause markets to be highly correlated after a financial crisis, a phenomenon known as financial contagion (Forbes and Rigobon, 2002). In this paper we investigate volatility contagion in REIT markets. While previous studies generally focus on asset returns, we examine financial contagion in depth from the volatility perspective. In particular, we employ the price range of REITs as a measure of volatility in this study. This range, defined as the difference between the highest and lowest asset price over a fixed time interval, has long been used as a proxy for volatility in finance. In contrast to return-based volatility, this range is more efficient and more informative regarding future volatility, as well as being more robust to market microstructure noise (Alizadeh et al. An obvious advantage of the price range is that for many financial assets it incorporates more information on price movements …