Modeling the Dependence Structure between Australian Equity and Real Estate Markets – A Copula Approach

31 Pages Posted: 22 Aug 2010 Last revised: 27 Aug 2012

See all articles by Stefan Trück

Stefan Trück

Macquarie University Sydney - Department of Applied Finance and Actuarial Studies; Financial Research Network (FIRN); Centre for International Finance and Regulation (CIFR); Macquarie University, Macquarie Business School

Ning Rong

Macquarie University

Date Written: June 22, 2010

Abstract

In the last decade, the Australian market for Real Estate Investment Trusts (REITS) has shown substantial growth rates. Australian Real Estate Investment Trusts (AREITS) are a unitized portfolio of property assets which allows investors to purchase a share in a diversified and professionally managed portfolio of real estate. We apply conditional copula models in order to investigate the dependence structure between returns of AREITS and Australian equity markets. The dynamic analysis is based on an AR-GARCH approach to model time-varying volatility of the individual series in combination with different copulas to capture the dependence structure between the standardized residuals. The Gaussian, Student t, Clayton and Gumbel copula are fitted and so-called ‘blanket’ goodness-of-fit tests are conducted in order to examine the appropriateness of the different copula functions. We also compare the suggested copula models to a standard variance-covariance approach and the Dynamic Conditional Correlation (DCC) model. We find significant positive correlation between the series what somehow contradicts earlier studies on the topic finding negative or only weak positive correlations between REITS and equity investments. Therefore, for Australian markets the diversification potential of investments in REITS might be less significant than for overseas markets. We also find significant tail dependence, in particular in the tail dependence structure that is best modelled by the Student t copula. Conducting a back-testing Value-at-Risk study for a portfolio combining investments in real estate and equity we find that the conditional copula as well as the DCC model significantly outperforms a static variance covariance approach. Our findings suggest that ignoring the complex and dynamic dependence structure in favour of a simple multivariate normal model leads to a significant underestimation of the actual risk.

Keywords: REITS, Dependence Structure, GARCH, Dynamic Correlation, Copula Models, Goodness-of-Fit Tests, Risk Analysis

Suggested Citation

Trueck, Stefan and Rong, Ning, Modeling the Dependence Structure between Australian Equity and Real Estate Markets – A Copula Approach (June 22, 2010). Available at SSRN: https://ssrn.com/abstract=1663152 or http://dx.doi.org/10.2139/ssrn.1663152

Stefan Trueck

Macquarie University Sydney - Department of Applied Finance and Actuarial Studies ( email )

North Ryde
Sydney, New South Wales 2109
Australia
61298508483 (Phone)
61298508483 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Centre for International Finance and Regulation (CIFR) ( email )

Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

Ning Rong (Contact Author)

Macquarie University ( email )

North Ryde
Sydney, New South Wales 2109
Australia

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
189
Abstract Views
1,142
Rank
289,210
PlumX Metrics