2006 V34 1: pp.

109131

REAL ESTATE
ECONOMICS

Asymmetric Volatility, Correlation and

Returns Dynamics Between the U.S. and
U.K. Securitized Real Estate Markets
David Michayluk, Patrick J. Wilson and Ralf Zurbruegg
We construct synchronously priced indices of securitized property listed on the
New York Stock Exchange and London Stock Exchange. The indices are then
utilized to examine dynamic information flows between the two markets. By analyzing returns behavior, asymmetric volatility spillover effects and exceedance
correlations, this study shows that the real estate markets in these two countries
experience significant interaction on a daily basis when synchronously priced
data are utilized. These results are different from when close-to-close returns
are examined, implying that the use of close-to-close data can misconstrue the
true dynamics that exist between these markets. Results also show significant
asymmetric effects on both the volatility and correlation dynamics between the
markets. This has several implications for property portfolio managers, indicating that positive and negative news impact the markets differently. This is
particularly true for the United Kindom, where daily foreign news from the United
States can influence U.K. volatility.

In this study, we provide an analysis of the pricing dynamics shared between

the U.S. and U.K. securitized real estate markets. To date, property research has
failed to examine the daily dynamics inherent between the various international
property markets and the implications it has for property portfolio performance.
Specifically, little attention has been placed on examining contemporaneously
quoted property prices for the markets operating in different time zones and
the asymmetry effects that foreign news can have on a local property market,
despite it being the norm for most financial analyses on equity and fixed-income
instruments.
One reason for this may be the property sector being considered by many
to behave differently in the way they interact with other financial assets and
international markets. Although securitized property markets may well interact

School of Finance and Economics, University of Technology, Sydney, Australia 2007

or David.Michayluk@uts.edu.au.
Sydney School of Finance and Economics, University of Technology, Sydney,
Australia NSW 2007 or patrick.wilson@uts.edu.au.

School of Commerce, University of Adelaide, Adelaide, Australia 5005 or

Ralf.Zurbruegg@adelaide.edu.au.

110 Michayluk, Wilson and Zurbruegg

with one another, the immobile nature of the underlying physical asset leads
to demographics and geography being generally viewed as major determinants
for the value of property. These localized factors are therefore considered to
be more important than perhaps foreign daily news events that impact other
financial assets, which can also lead to a greater co-movement between assets
in different countries.
This may also explain why there is evidence that property markets are less
globally integrated than other financial assets. With less integration between
national property sectors, correlations would normally be expected to be lower
and the benefits to diversification higher. For instance, Asabere, Kleiman and
McGowan (1991), in a study on the role of indirect property holdings in a mixed
asset portfolio over the 19801988 period, demonstrated that there were benefits
to international diversification of real estate assets. These researchers found
low positive correlations between U.S. real estate investment trusts (REITs)
and international real estate equities. This finding was supported in a study
conducted by Hudson-Wilson and Stimpson (1996). These analysts examined
the inclusion of U.S. securitized real estate in Canadian property portfolios over
the period 19801994, finding that Canadian investors would have benefited by
the inclusion of U.S. real estate in their portfolios.
In a more extensive study that included nine countries from 1985 to 1994,
Eichholtz (1996) found significantly lower cross-country correlations for real
estate returns than for either common stock or bond returnsimplying greater
segmentation in real estate than other assets. Eichholtz suggested that a possible
reason for the lower correlations for real estate may be that real estate is more
influenced by local factors than is the case for either stocks or bonds.
Apart from evidence suggesting property markets are less integrated with one
another, there is also very little evidence showing real estate markets are susceptible to daily information flows that arrive from local and foreign sources. In
one of the few studies on the link between news events and real estate, Schwann
and Chau (2003) looked at news effects and structural shifts in price discovery
(the information transfer from securitized to direct real estate) in Hong Kong
over the period 19861999. Their expectation was that there would be a less
than full transfer of information from indirect to direct property markets as a
result of news events if such news was external to the real estate sector. To
test their hypothesis the events considered by these authors were abnormally
large returns in the securitized property sector that were occasioned by general
international capital market movements. The outcome from their analysis supported their expectation in that these authors found the price discovery effect
to be significantly reduced in the period following such news events. Glascock,
Michayluk and Neuhasuser (2004) also show that the riskiness of REITs to

Asymmetric Volatility, Correlation and Returns Dynamics 111

market downturns may be less than with other equity. This, in part, is probably
due to the specific features underlying the value of securitized stocks, that being
physical property.
This paucity of research on the subject is, in part, due to the lack of available
high-frequency observations for the direct appraisal property market other than,
possibly, monthly statistics. However, the same cannot be said for the securitized
realty market for equity listed property holding companies. Although there is
some contention that an analysis of securitized property will not necessarily
lead to the same results as that for direct property, there is a growing amount
of the literature showing the strong relationship between the two. Namely,
indirect property markets seem to move with an approximate 69 month lead
time over the direct market. As property holding companies are fundamentally
priced on the value of their physical assets, there is no reason to suspect the
two markets will deviate very far from each other over the long term. Research
by Kallberg, Liu and Pasquariello (2002), for instance, has shown that the
correlations between direct and indirect property returns for Asian real estate
markets are relatively strong, with the securitized market leading to changes in
the direct, physical market. Barkham and Geltner (1995) also show, in a study
on price discovery for the U.S. and U.K. real estate markets, pricing behavior
did transmit from indirect to direct property markets with varying time lags.1
As there has effectively been no detailed study of daily pricing dynamics for the
international real estate market, this article analyzes daily information flows between two of the most heavily traded securitized property markets in the world,
the United States and United Kingdom. By constructing synchronously priced
realty indices for property holding companies trading on the London Stock Exchange (LSE) and the New York Stock Exchange (NYSE), this study examines
the pricing dynamics that exist between these two markets and provides an indication of the time-varying correlation structure that exists. This is achieved by
estimating the variance-covariance structure of the markets using an asymmetric
covariance GARCH model proposed by Kroner and Ng (1998). This will allow
for asymmetric volatility spillover effects to be observed, along with accounting
for an asymmetry in the correlation dynamics from negative and positive news
shocks entering both the markets. This is of invaluable importance given it has
been shown that, for more common equity indices, asymmetric effects can be
quite large and can have an impact on the benefits to diversification (see Martens
and Poon 2001). Also, and as a means of comparison, exceedance correlations
are calculated, following the methodology of Ang and Chen (2002). This will

See also Schwann and Chau (2003), Chau, MacGregor and Schwann (2001) and
Newell and Chau (1996).

112 Michayluk, Wilson and Zurbruegg

allow for another means to analyze the asymmetry of the correlation structure
between the two markets.
The rest of the article examines the above in more detail. The next section explains how the data were constructed. The third section details the methodology
employed to examine pricing dynamics, with the fourth section providing the
empirical results. The final section concludes with comments on the significance
of the results discussed in this article for property portfolio managers.
The Data and Preliminary Statistics
In order to examine the pricing dynamics between the U.S. and U.K. securitized property markets, the issue of synchronicity first needs to be addressed.
Research by Martens and Poon (2001) has shown that the use of close-to-close
returns can underestimate return correlations for markets that trade at different times. Moreover, previous studies, such as by Hamao, Masulis and Ng
(1990) and Koutmos and Booth (1995), who only utilized opening and closing
prices, have found it difficult to differentiate between contemporaneous and
lagged spillover pricing effects from one market to another. This all leads to
a distortion in the observed pricing dynamics where one market may seem to
lead another, simply because its closing time is ahead of another market. The
information bias would always favor the market that closes first.
A second problem, that of liquidity, is more specific for the property market.
It has only been in recent years that trading in REITs has grown substantially
enough to note active intra-day trading. There are now more than 300 REITs
trading in the United States whose average daily volume has more than quadrupled in the last three years, reaching $280 million per day.2 For most of the
markets around the world, far fewer property stocks are traded on a regular
basis. This can lead to a delay in the perceived reaction that one market has
to news affecting a foreign market. Lagged reactions may give the appearance
markets are insulated from foreign events.
In order to overcome the above two problems, we construct unique indices for
the U.K. and U.S. securitized real estate markets that eliminate infrequently
traded stocks, with prices quoted in both exchanges at 15:30 GMT. This ensures that the indices are synchronously timed, despite the different opening
and closing periods of the two exchanges. For each stock exchange, one simultaneous price is obtained for each real estate company and an index is formed
that is the summation of all real estate companies on that exchange that trade

Source: Investopedia.com.

Asymmetric Volatility, Correlation and Returns Dynamics 113

regularly.3 A logarithmic return measure is then calculated for each day. The
source of the U.S. data was the NYSE trades and quotes database, with 127
REITs included within the index. REITs were identified using the National Association of Real Estate Investment Trusts data set. For the United Kingdom, 41
companies make up the index, identified using the European Public Real Estate
Association (EPRA) listings.4 The actual time period under study ranges from
January 4, 2000, to October 31, 2003, leading to a total of 935 observations. If
there was a holiday on any of the trading days in one market, then that day was
deleted.
It is also important to explicitly point out that the statistical characteristics to
be presented for the U.K. and U.S. series may also be due to the differences in
composition between the series. Specifically, the U.S. index is entirely made up
of REITs. REITs have to pay out 90% of their earnings as dividends to avoid
taxation as separate entities. The U.S. real estate market is also comparatively
large, with, according to EPRA, ten companies included in the worlds top
20 ranked by free-float capitalization. Average market capitalization in October 2003 for the constructed index was $1,261 million. There is no REIT-like
structure in the United Kingdom, and firms earnings are taxable. According
to Ooi (2001), the U.K. property sector paid out 44% of earnings as dividends
(in the 19861998 period). The size of the U.K. property market is smaller
with only two U.K. firms included in the worlds top 20 ranked by free-float
capitalization. However, the U.K. market does constitute 51% of the EPRA
index, being relatively large for Europe. The average market capitalization for
our constructed U.K. index was $745 million in October 2003, representing a
little more than half of that for the United States.
Although both the constructed indices have removed the problems associated
with thin trading, it can be seen from above that the general composition of
the real estate indices between the United States and the United Kingdom are
not identical. This will obviously lead to differences in how the indices behave
relative to each other due to exogenous shocks to the system. For example,
due to the differences in tax regime between the two countries, U.K. real estate
companies are more likely to borrow money as a tax-effective means of raising
capital. With relatively lower free floats, the impact from interest rate changes
will undoubtedly be more noticeable in the U.K. market.

3
4

Each stock is examined to ensure live quotes are given for each day at 15:30 GMT.

Initially there were a total of 176 U.S. and 71 U.K. stocks that were targeted for
constructing the index. However, only company stocks that reported trading on every
day were included in the final index.

114 Michayluk, Wilson and Zurbruegg

Despite these structural differences in the indices and the way they would
possibly react to the economic environment, both indices are representative of
the current securitized real estate market in their respective countries. International portfolio managers on a regular basis invest in national realty markets
to purposely diversify their risks from one market to another. The impetus to
do this increases if the legal, tax and economic environments lead to differing
property price behavior between various markets. However, there nevertheless
will exist an interrelationship between various national property markets. This,
therefore, still poses the question as to how this relationship functions between
two of the largest securitized property markets in the world, and whether there
is a transfer of information from one market to another on a frequent, day-today basis. If there is, as is the case with common stocks, then the securitized
real estate company prices can be shown to be just as affected by international
property returns. In fact, given that a significant proportion of the U.S. and U.K.
real estate companies hold investments in each others country, one would in
fact expect a relationship between the two markets, regardless of institutional
and other structural differences.
As a further means of comparing the statistical distribution characteristics of our
constructed series to standard closing price data that are popularly used, we also
collect daily closing prices from Datastream International securitized property
indices for both the United Kingdom and United States. The Datastream real estate series are constructed to reflect the broad nature of the property companies
trading on the various stock exchanges. So, for example, in the United Kingdom there are essentially two types of property companies that trade on the
LSE, namely investment companies and developer-traders (Ball, Lizieri and
MacGregor 1998). Investment companies acquire or develop properties and
then retain them, while developer-traders either construct and sell or acquire,
refurbish and sell. Property companies in the United Kingdom do not receive
any special tax treatment and the 31 companies making up the Datastream U.K.
real estate index consist of both of these company types. In the United States, a
REIT is a property company structured under the rules of the Estate Investment
Trust Act of 1960 (Corgel, Ling and Smith 2001). Provided certain criteria are
met a REIT is not taxed at a company level. The 46 companies making up
the Datastream U.S. real estate index are REITS. Compositional differences
will, therefore, exist between both the constructed synchronous series as well
as the Datastream series. As will be discussed further, this will inevitably also
influence the empirical results from this study.
Comparing the synchronous and Datastream indices will also determine how
important it may be to quote synchronously priced indices. If, for example,
there is very little difference between the synchronous and close-to-close series,
then five-hour time delays (representing the difference in time between the LSE

Asymmetric Volatility, Correlation and Returns Dynamics 115

Table 1  Descriptive statistics for the U.K. and U.S. property indices.
Synchronous Returns

Mean
Standard Deviation
Skewness
Kurtosis
Maximum
Minimum
No. Companies
Jarque-Bera

Close-to-Close Returns

U.S.

U.K.

U.S.

U.K.

0.0004
0.0078
0.1836
13.218
0.0642
0.0438
127
4073.1a

0.0002
0.0070
0.9133
9.2463
0.0329
0.0529
41
1650.0a

0.0004
0.0085
0.0599
5.3049
0.0463
0.0358
46
207.5a

0.0001
0.0096
0.2603
6.4725
0.0490
0.0506
31
480.3a

The tabulated descriptive statistics are for daily data ranging from January 4, 2000
to October 31, 2003. The synchronous series are from the constructed index where
prices are quoted at 15:30 GMT each day. The close-to-close returns series represent
the Datastream property series for each country. Returns are calculated as continuous,
logged returns.
a
Signifies rejection of the null hypothesis of normality at the 1% critical level using the
Jarque-Bera (1980) test for whether the series follows a normal distribution.

close and NYSE close) would not seem to significantly affect the property stock
price quotes, and therefore using non-synchronous closing price data would be
acceptable practice. If a difference does exist, it will most likely come from
a variation in the measurement of the spillover effects one market will have
on another. In particular, one would expect to see the U.K. market having a
significant impact on the U.S. contemporaneous price behavior, as it would have
impounded several hours worth of news information in its prices. An erroneous
lead-lag relationship might prevail, where the U.K. market would seem to be
driving the U.S. property returns. Tables 1 and 2 provide the basic statistics and
cross-correlations between the United States and United Kingdom, using both
the synchronous and close-to-close Datastream returns series.
Despite the mean returns for the synchronous data being slightly higher than
the close-to-close returns series, the differences are statistically insignificant.5
For both the synchronous and close-to-close data, the U.S. average returns are
the same or higher than in the United Kingdom. However, volatility is larger
using close-to-close data.6 This is interesting, as it suggests the dispersion

5
6

Simple t tests show no differences in mean returns between the series.

Using simple F tests to compare sample variances, volatility is significantly larger

for both the U.K. and U.S. close-to-close returns at the 5% significance level with a
F-critical value of 1.1137 against F-test statistics of 1.879 and 1.167 for the United
Kingdom and United States, respectively.

116 Michayluk, Wilson and Zurbruegg

Table 2  Cross-correlations for the U.K. and U.S. property indices.

Synchronous Returns

Close-to-Close Returns

Lead/Lag
Order (i)

U.K. Against
U.S. (Lag i)

U.K. Against
U.S. (Lead i)

U.K. Against
U.S. (Lag i)

U.K. Against
U.S. (Lead i)

0
1
2
3
4
5

0.1645
0.1423
0.0944
0.0703
0.0347
0.0057

0.1645
0.0458
0.0307
0.0281
0.0393
0.0046

0.1978
0.1224
0.0490
0.0927
0.0253
0.0097

0.1978
0.0065
0.0301
0.0342
0.0292
0.0033

The tabulated descriptive statistics are for daily data ranging from January 4, 2000
to October 31, 2003. The synchronous series are from the constructed index where
prices are quoted at 15:30 GMT each day. The close-to-close returns series represent
the Datastream property series for each country. Returns are calculated as continuous,
logged returns.

of returns are generally larger for the nonsynchronous series. This is despite
the maximum and minimum range for both the U.K. and U.S. indices being
larger with the synchronous data. This may be due to the Datastream series
having a smaller number of listed companies within its index. All markets also
demonstrate excess kurtosis, which can be due to the presence of conditional
heteroskedasticity in the data-generating process. Along with the presence of
skewness, this leads to none of the series being normally distributed, failing
the Jarque-Bera test for normality. All series are also stationary in differences
(logged returns) when Augmented Dickey-Fuller tests were conducted.7
When comparing correlations between the synchronous and close-to-close data,
relatively small differences exist. The synchronous returns data show a correlation of 0.1645, whereas the Datastream series has a correlation of 0.1978.
For the lagged cross-correlations, the synchronous data seem to follow a more
orderly decay structure than the close-to-close returns. Right up until the fifth
lag the cross-correlation between the two markets declines in value for the synchronous data. Possibly due to the nonsynchronicity of the Datastream series,
this same statistical trait is not observed for the close-to-close returns. With
a five-hour lead time over the United States, a potential bias arises from the
U.K. market unduly influencing the U.S. market closing prices. This would naturally exert itself within the cross-correlation structure between the markets.
However, to more formally determine the impact that the two closing times
7

ADF test statistics for the U.K. and U.S. Datastream property series in differences are
12.536 and 13.79, respectively. For the synchronous series they are equal to 12.11
and 14.64, respectively. The ADF 1% critical value is 3.44.

Asymmetric Volatility, Correlation and Returns Dynamics 117

have on the data, the empirical results from the GARCH model need to be
examined.
GARCH Processes and Exceedance Correlations
This study utilizes the Asymmetric Dynamic Covariance (ADC) model proposed by Kroner and Ng (1998). The ADC model encompasses several popular
multivariate GARCH models within its framework, while allowing for asymmetric effects to appear within the conditional variance-covariance process. For
the bivariate case with returns, Rt , the mean equation allows for a simple constant term, i , with the error, it , to follow a GARCH process defined by H t .
The conditional mean equation can be notionally written as:
Rit = i + it

for i = 1, 2,

(1)

it | t1 N (0, Ht ).
The conditional variance process, hiit , is defined as
h iit = iit

(2)

and the conditional covariance, h12t being

 
h 12t = 12 11t 22t + 12 12t ,

(3)

where ijt is


ijt = ij + Bij h ijt1 + ai t1 t1
a j + gi t1 t1
gj

for all i, j,

(4)

and ai = [a i1 , a i2 ] , g = [g i1 , g i2 ] , and = [min (0, t1 ), min (0, t2 )] being

the asymmetric innovations term that is equal to the error term if the residual
is negative, or the value is zero if the residual is positive.
To explain in more detail the construction of the above model, it is important
to highlight one significant advantage that the ADC model holds over various
other bivariate GARCH processes, namely, it is flexible enough to nest several other more restrictive variance-covariance structures within its framework.
Specifically, one of the major problems that emerge when examining a multivariate GARCH system is how the conditional covariance should be structured.
Problems with ensuring convergence of the system of equations plus guaranteeing sensible parameter results (such as a correlation coefficient being within
an absolute value of one) can lead to erroneous results. Bollerslev (1990) first
proposed a simple constant correlation model, where the conditional covariance that is detailed in Equation (3) would be the square root of the product
of the conditional variances for each series (i.e., the second term, 12 , would

118 Michayluk, Wilson and Zurbruegg

not exist). The parameter 12 would then effectively represent the constant
conditional correlation for the whole sample period. This would limit the number of parameters that would need to be calculated, but at the expense of not
allowing for a more dynamic correlation function.
Another measure for determining the conditional covariance is the Bollerslev,
Engle and Wooldridge (1988) VECH representation, which would effectively
become an ARMA model for the product of the error terms, it jt , where the
conditional covariance follows the representation outlined in Equation (4). The
B vector represents the lagged conditional covariance parameter. The a represents the lagged residual values. The g represents the asymmetric coefficient
terms that allow for a difference in whether an exogenous shock is negatively
or positively received in the market. For the ADC model, this would imply
that within Equation (3), 12 would take on the value of zero leading to ijt in
Equation (4) to represent the conditional covariance process with some further
imposed constraints on the vector a and values of Bij (so that, for example, the
total parameter values are less than one, otherwise it would lead to exploding
error terms).
Two other models include the BEKK model proposed by Engle and Kroner
(1995) and the Factor ARCH model by Engle, Ng and Rothschild (1990). The
BEKK representation imposes further restrictions on the conditional covariance
structure to ensure positive definiteness during computation, while allowing for
the conditional covariance to be determined by the vector of past error terms.
If in Equation (3) the constant correlation term 12 is set to zero and 12
is set to one you are left with the BEKK model for the conditional covariance
structure. The Factor ARCH model is a special case of the BEKK representation,
further constraining the vector a and the values of Bij to limit the number of
parameters that need to be incorporated within the model in order to facilitate
model estimation.
By parameterizing the conditional covariance in the manner detailed in Equations (3) and (4), all the above discussed covariance representations are incorporated into the ADC model and allow for a test to determine which covariance
framework is more suited to explain the time series under analysis. This includes the Bollerslev (1990) constant correlation model if we find that 12 = 0,
the Bollerslev, Engle and Wooldridge (1988) VECH model if certain parameter
constraints are imposed on H t + 12 = 0, the BEKK model of Engle and Kroner
(1995) if 12 = 0 and 12 = 1 as well as the Factor ARCH model of Engle, Ng
and Rothschild (1990) if certain parameter constraints are imposed on H t and
12 = 0 and 12 = 1. The economic significance of all this is that the model
allows us to determine the general structure that the conditional covariance,
and thereby correlation, between the U.S. and U.K. property markets follows.

Asymmetric Volatility, Correlation and Returns Dynamics 119

If, for example, we find that 12 = 0 and 12 = 0, then it implies correlations

are in fact generally constant over the sample period and that portfolio managers do not need to regularly rebalance portfolios due to a changing correlation
structure that might alter diversification benefits from different asset holdings.
Modeling the conditional variance correctly is therefore particularly important
in this context.
Other than the above framework being able to encompass several other multivariate models, the ADC representation provides a simple yet effective means
to examine the conditional volatility spillover effects between the U.S. and
U.K. securitized property markets, while also accounting for any asymmetry
that might exist between unexpected positive and negative news events. This,
in itself, is important as much attention has recently focused on the asymmetric
effects that exist in financial asset markets where negative events seem to lead
to larger effects upon markets and correlation structures (e.g., Ang and Bekaert
2000; Bae, Karolyi and Stulz 2000; Bekaert and Wu 2000). The results from
estimating this model will therefore be able to build a comprehensive picture
of the volatility dynamics that exist as well as the possible asymmetric conditional correlation structure that emerges from the interaction between these
two markets. Despite the unique features inherent within property, there is no
reason to suppose that asymmetric effects will also not be present within the
securitized property market.
Recent literature has, however, called into question the consistency that is obtained from modeling the correlation between series using different GARCH
processes. Engle (2002) has shown that observed conditional correlations from
different GARCH models can lead to sometimes substantial differences. Although the ADC framework is one of the more flexible options available to
model bivariate series, it is by no means the only option. Therefore, and primarily as a means to check any asymmetry patterns that might emerge in the
correlation structure between the two series, exceedance correlations are also
calculated.
An exceedance correlation refers to the correlation between two variables at
given tail levels in their respective distributions. For example, suppose the two
variables refer to an individual equity stock (or portfolio of stocks) and the
market index, respectively.8 It has been demonstrated by Longin and Solnik
(2001), Ang and Chen (2002) and Hong, Tu and Zhou (2003), among others,
that there are asymmetric correlations on upside versus downside movements
in the stock market. Upside/downside correlations are defined as when the

Or, in our case, the real estate indices of two international markets.

120 Michayluk, Wilson and Zurbruegg

individual stock (or portfolio) and the aggregate market return are above/below
some prespecified level.
Boyer, Gibson and Loretan (1999) and Forbes and Rigobon (2002) have also
shown that correlations conditional on certain scenarios, such as high returns or
low volatility, induce a conditioning bias in correlation estimates. That is, any
bivariate normal distribution has an unconditional correlation, . However, the
correlation calculated on a subset of observations above or below some given
level (i.e., the conditional correlation, ),
will differ from the unconditional
correlation, .
Ang and Chen (2002) develop an exceedance correlation measure that looks
at the behavior in the tails of the distribution and which corrects for this conditioning bias. Essentially, Ang and Chen define an exceedance correlation to
be the correlation between two variables when both of these variables register
increases or decreases of more than standard deviations above or below their
means such that


(,

, , ) = corr (x , y /x > , y > ; ) if 0

()

=
(,

, , ) = corr (x , y /x < , y < ; ) if 0

(5)
where, adopting similar notation to Ang and Chen (2002), is the exceedance
correlation, are standard deviations above or below the mean, x and y are
standardized observations on variables x and y, is the conditional correlation and is the unconditional correlation. So, in calculating ,
subsets of
x and y when x > and y > for 0 (and vice versa for the downside estimates) are taken. The correlation of observations in the subset is the empirical
exceedance correlation at .
The results obtained from this analysis, along with the estimation results from
the ADC model, are all presented in the next section, showing whether there
is evidence of volatility spillovers and asymmetry in the variance-covariance
structure.
Empirical Results
Volatility Spillovers
Table 3 reports the ADC model estimation results9 for both the synchronous
and close-to-close returns indices. Even though the closing times between the

The ADC model was estimated using maximum likelihood, utilizing a Berndt, Hall,
Hall and Hausman (1974) algorithm for optimization.

Asymmetric Volatility, Correlation and Returns Dynamics 121

Table 3  Results from the ADC model for the U.K. and U.S. property indices.

Parameter
UK
US
UK
US
covariance
aUK
aUS on UK
aUK on US
aUS
gUK
gUS on UK
gUK on US
gUS

BUK
BUS
Bcovariance

Synchronous Returns

Close-to-Close Returns

Estimate

Standard Error

Estimate

Standard Error

0.0002
0.0002
0.0004
0.0007
0.0003
0.0656
0.0562
0.0350
0.0440
0.1398
0.0799
0.0929
0.0990
0.1149
0.2263
0.1388
0.0240
0.1871

0.0002
0.0004
0.0000
0.0028b
0.0061b
0.3943b
0.0678
0.0762a
0.3379b
0.1247b
0.2929b
0.1513a
0.2581b
0.0375
0.5217c
0.6349b
0.8423b
0.9475a

0.0003
0.0003
0.0063
0.0005
0.0007
0.0406
0.0689
0.0386
0.0439
0.0216
0.0961
0.0672
0.0822
0.1835
0.2674
0.0825
0.0354
0.3916

0.0005
0.0006b
0.0050b
0.0007
0.0019b
0.3738b
0.1378a
0.0696a
0.4283b
0.2930a
0.2346b
0.0585
0.1760c
0.0953
0.8239b
0.4608b
0.8453b
0.7673b

Heteroskedasticity-consistent standard errors are reported. The tabulated results are

taken from daily data ranging from January 4, 2000 to October 31, 2003.
a
Indicates t-test significance at the 5% level.
b
Indicates t-test significance at the 1% level.
c
Indicates t-test significance at the 10% level.
The conditional mean equation for the ADC model is expressed as:
Rit = i + it for i = 1, 2, where it | t1 N (0, Ht ). The conditional variancecovariance terms are:
h iit = iit
h 12t = 12 11t 22t + 12 12t ,


ijt = ij + Bij h ijt1 + ai t1 t1
a j + gi t1 t1
g j for all i, j,


where ai = [ai1 , ai2 ] , g = [gi1 , gi2 ] ,and = [min(0, t1 ), min(0, t2 )] being the
asymmetric innovations term that is equal to either the error term if the residual is
negative, or the value of zero is the residual is positive. i and j are the U.S. and U.K.
markets, respectively.
To aid interpretation, subscripts under relevant parameters have been added to denote the
U.K. and U.S. markets. For example, UK represents the constant term in the conditional
mean equation for the U.K. market, covariance represents the constant in the conditional
covariance equation, aUK represents the lagged squared U.K. residual term in the U.K.
conditional variance equation and gUK on US is the coefficient representing the asymmetric
impact from U.K. lagged squared innovations on the U.S. conditional variance
equation.

122 Michayluk, Wilson and Zurbruegg

LSE and NYSE vary by only a few hours, the impact this has when analyzing
volatility spillover effects is quite remarkable.
Focusing on the first two columns of figures, which represent the results from
using the synchronous data, it is apparent that lagged squared innovations from
either market have an immediate impact upon the U.K. and U.S. variances. The
same is true for the conditional covariance structure. Moreover, by examining
the size of the a vector spillover terms, the impact of a shock originating from
the U.S. market has almost double the effect of increasing the U.K. conditional variance (0.1378), as does a shock originating from the United Kingdom
have upon the U.S. conditional variance (0.0696). Although both parameters
are significant at the 5% critical level, it is evident that a shock originating
from the United States seems to lead to greater uncertainty in the covariancevariance framework between these markets.
The same can also be said for the asymmetric terms. There is no statistical
significance attributed to a negative shock arriving from the United Kingdom
affecting the U.S. conditional variance, although there is a highly significant
parameter value, at the 1% level of significance, for a negative U.S. shock impacting upon the U.K. market (0.2346). In fact, it is nearly as large in magnitude
as the impact from a lagged local negative shock (0.2930), signifying the importance of U.S. REITS volatility on U.K. securitized property. Very likely, this is
related to the U.K. property market sharing many similar economic factors with
the United States and many of the U.K. property companies having invested in
the U.S. market as well.
Moreover, the asymmetry volatility pattern exhibited within the U.K. market
(where negative shocks seem to have a more pronounced effect on volatility than
for the United States) may in fact be partially due to institutional and taxation
differences between the two countries. Due to the taxation regime in the United
Kingdom, where property companies do not benefit from not having to pay tax
on income as in the United States, there is a greater leverage effect. After a
negative shock, the debt-to-equity ratio of the company would rise. However, if
volatility for the whole firm is assumed to be constant, then the volatility of the
nonleveraged portion of the firm, that is, its equity, would need to increase. This
issue is commonly used as an explanation for noting an asymmetry effect in
GARCH processes; Black (1976) and Christie (1982) examine it in more depth.
In this particular study, due to the differences in taxation regime, negative shocks
upon the U.K. market do seem to have a larger impact than for the United States,
regardless of whether the shock originates from its own or foreign market. Very
likely this is because of the more pronounced leverage effect in the United
Kingdom.

Asymmetric Volatility, Correlation and Returns Dynamics 123

As a comparison with more standard equity indices, Martens and Poon (2001),
who examine synchronously priced stock indices in the United States and United
Kingdom, report a greater bidirectional pattern of information shocks than
this study shows. Whether the shocks are positive or negative, they all lead
to significant changes in the U.K. and U.S. conditional variances, regardless
of which market the shock originated from. Work by Cappiello, Engle and
Sheppard (2003) also support these findings, showing equity markets in several
developed markets demonstrate significant bidirectional information flows to
shocks from one market to another.
Also, and in contrast to the property data analyzed in this study, Martens and
Poon (2001) indicate that the greatest volatility shock is caused when a large
negative local return coincides with a large positive foreign return. The same
is definitely not the case for the subset of equity listed stocks of property holding companies. We observe that a large negative shock in the foreign market,
accompanied by a large negative shock in the domestic market, leads to the
greatest amount of volatility.10 This does make sense, as in property markets if
there is negative news in a large foreign market it would simply compound with
any negative news from the local market. Again, for the United Kingdom this is
particularly true and may not only be related to the fact that the United States is
a significant trading partner, but also to the fact that U.K. property companies
hold significant investments in the United States, making them more susceptible
to U.S. market volatility.
The above results can be more clearly seen in the news impact surfaces (NIS)
that are shown in Figure 1. For both the U.K. and U.S. conditional variances
(Figure 1(a) and (b)), an asymmetric pattern is noted where negative shocks lead
to greater rises in the conditional variances than do positive shocks. Although
not as apparent for the U.K. market, the greatest variance is experienced when
there are combined large negative shocks from both the United States and the
United Kingdom. Also, as can be seen from the skewed shapes of the NIS, U.S.
shocks do have a greater impact than U.K. lagged residual returns do.
Synchronous versus Close-to-Close Returns
To provide a comparison between the above synchronous data results and those
that would be obtained from popularly used close-to-close returns, the last two
columns in Table 3 show the estimation results for the Datastream indices. The

10
Due to the asymmetric behavior in the market, there is a slightly lower impact on
volatility from dual positive shocks in both markets upon the conditional variances.

(b)

(d)

(a)

(c)

Figure 1  News impact surfaces for the synchronous indices results from the ADC model. Figures show the conditional variances for the United States (a) and United Kingdom (b), the conditional covariance between the United
States and United Kingdom (c) and conditional correlation (d) against U.S. and U.K. shocks from the previous
period (U.S. t1 and U.K. t1 on the horizontal axes with resulting variances, etc., on the vertical axis). The impact
surfaces are calculated by generating conditional variances and covariances from the ADC model from innovations
ranging from 0.04 to 0.04 in value. The axis values have been multiplied by 100 for ease of reference. The ADC
parameters were set according to the values tabulated in Table 3 for the synchronous series. In estimating these innovations, the past conditional variances and covariance are held constant at their unconditional sample mean levels.
The axis for the conditional covariance and correlation graphs are reversed to provide a better visual viewing angle.

124 Michayluk, Wilson and Zurbruegg

Asymmetric Volatility, Correlation and Returns Dynamics 125

results are revealing, as they are strikingly different to the results obtained from
the synchronous data. U.K. shocks now influence the U.S. market more than
before and the U.S. market has a diminished impact upon the U.K. market.
Specifically, the asymmetric term expressing the influence of a negative U.K.
shock upon the contemporaneous U.S. variance is now significant (0.1513),
whereas the impact on the U.K. conditional variance from a lagged squared
residual return from the United States is no longer significant (0.0678).
This, however, is to be somewhat expected, as after the U.K. market closes there
are five hours of trading remaining on the NYSE. This leads to an information
flow bias from the United Kingdom to the United States. These results, apart
from highlighting the importance of using synchronous data, also indicate how
liquid the U.K. and U.S. securitized realty markets are. If there was little difference between the two data sets, in terms of volatility spillovers, then it would
have suggested the time delay between closing prices in both the exchanges
does not play a significant role in influencing the pricing dynamics between
these markets. However, as there is a significant difference in the results, the
information dynamics that exist between the two markets obviously react on
a high frequency basis. The use of intra-day data can therefore not be ignored
within the securitized real estate market.11
Correlation Dynamics
Turning our attention to the correlation between the U.K. and U.S. indices, the
pattern exhibited by the covariance NIS for the synchronous data (Figure 1(c))
highlights the asymmetry that surrounds the pricing interaction between the
two markets. It also provides visual evidence supporting the existence of a
complex correlation structure that simple GARCH processes probably would
not pick up on. In fact, the constant correlation process of Bollerslev (1990) is
rejected, with greater support for the BEKK Engle and Kroner (1995) covariance
representation, as simple t tests cannot reject 12 = 0 and 12 = 1.12 This implies
that it would be wrong to simply assume the correlation between the United
Kingdom and United States is constant, as a much more dynamic approach
seems to capture the conditional correlation structure far better. The NIS for the
conditional correlation between the U.K. and U.S. markets (Figure 1(c)) also
reinforces the asymmetric nature of the data, as large simultaneous negative
11
Alternatives to close-to-close returns were also examined, including the usage of
opening prices and synchronicity adjustments (such as those proposed by Burns, Engle
and Mezrich (1998)), but none achieve similar results to those obtained from using the
synchronous data.
12
A likelihood ratio test for joint significance of 12 = 0 and 12 = 1 can also not be
rejected.

126 Michayluk, Wilson and Zurbruegg

shocks from both markets lead to a higher correlation than do positive shocks.
This further supports the work of De Santis and Gerard (1997), among others,
who indicate correlations for equity markets tend to be higher during bear
markets than bull markets. The same is true for property markets; Wilson and
Zurbruegg (2004) have shown that during crises periods correlations between
property markets also rise. Diversification benefits are therefore not as high as
previously thought; during times when investors would most want to benefit
from diversification, correlations increase. This also seems to be the case for
an international property portfolio.
As an alternative to examining the conditional correlation derived from the
ADC model, and to check that this asymmetry is not simply a product of the
GARCH representation chosen, the exceedance correlations for the two series
are graphed in Figure 2. Following Ang and Chen (2002), the figure shows the
exceedance correlations for exceedance levels ranging from 0 to 1.5 standard
deviations on either side of the series distribution. Although there is no orderly
decline, returns correlations do decay as one moves up the positive tail of the
distribution, hitting the zero correlation axis after moving over one standard
deviation. For negative returns, the declining pattern is not as steep and, in fact,
does not decrease below a correlation of 0.38 when the exceedance level is 1.5.
In other words, large negative shocks in the United Kingdom and United States
lead to higher correlations than do large positive shocks. This is synonymous
with results for the equity markets where both Longin and Solnik (2001) and
Ang and Chen (2002) note higher exceedance correlations for negative shocks.
However, they do differ from that of equity where exceedance correlations
generally seem to more steadily increase as one moves further away from the
zero standard deviation line for negative shocks. For real estate, this pattern is
not so apparent, as the size of a negative shock does not seem to bear that much
influence on the actual exceedance correlation, which is pretty similar when
one moves from 0.5 to 1.5 standard deviations.
Asymmetry is still, nonetheless, prevalent within the correlations. A symmetry
test devised by Hong, Tu and Zhou (2003) produces a test statistic of 13.26,13
with a p value of 0.01. The symmetry test has a null hypothesis of symmetric
correlations for both sides of the tail distributions, with the alternative of asymmetry. The test statistic, therefore, reinforces the notion that the correlation is
asymmetric for the two real estate indices.
These results have a direct implication on how investors should perceive information shocks that enter the local market from abroad. As discussed earlier,
13
The Hong, Tu and Zhou (2003) symmetry test is discussed in detail in their article and
we follow the same technique of using the Bartlett kernal to calculate the test statistic.

Asymmetric Volatility, Correlation and Returns Dynamics 127

Figure 2  Correlations between the U.S. and U.K. property index return exceedances.
The correlation structure for the return exceedances are graphed for exceedance levels
ranging from 1.5 to +1.5 standard deviations. Ang and Chen (2002) define an
exceedance correlation to be the correlation between two variables when both of these
variables register increases or decreases of more than standard deviations above or
below their means such that


(,

, , ) = corr(x , y /x > , y > ; ) if 0

()

=
(,

, , ) = corr(x , y /x < , y < ; ) if 0

where is the exceedance correlation, are standard deviations above or below the
mean, x and y are standardized observations on variables x and y, is the conditional
correlation and is the unconditional correlation. So, in calculating ,
subsets of
x and y when x > and y > for 0 (and vice versa for the downside estimates)
are taken. The correlation of observations in the subset is the empirical exceedance
correlation at . For the figure, the data utilized were the daily synchronous index
returns from January 4, 2000, to October 31, 2003, quoted at 15:30 GMT each day.
The usual correlation coefficient using all returns is 0.1645 (from Table 2) and is
represented on the graph by the bold dot. Apart from the visual appearance of the
actual figure, a Hong, Tu and Zhou (2003) test confirms the correlation is asymmetric
at the 1% critical value for the two real estate series with a test statistic of 13.26.

Exceedance Correlations

0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
-0.1
-0.2
-0.3
-1.5

-1

-0.5

0.5

1.5

Standardized Exceedance Levels

bear markets lead to greater volatility. However, this is now also compounded
with a larger correlation than what would be seen if there was a positive price
shock affecting the market. For a property portfolio manager this implies that, as
with many other financial assets, protecting against negative market shocks by
diversifying portfolio holdings between different markets will not necessarily
work as well as expected. This would at least be the case for two of the larger
property markets in the world, namely the United Kingdom and United States,
as correlations do rise above the mean during periods when large negative news
events affect the market.

128 Michayluk, Wilson and Zurbruegg

Conclusion
By examining the volatility spillover effects plus the correlation structure inherent between the U.S. and U.K. securitized property indices, several pricing
characteristics appear to significantly influence the behavior of the interaction
between the two markets. First, when using synchronous data, U.S. volatility
has a significant effect upon U.K. conditional variances. This volatility effect is
also asymmetric in nature, with a greater impact arising from a negative shock
(primarily due to the leverage effect as U.K. property companies already have
larger debt-equity ratios). The same is not true of the U.K. market influence
upon U.S. REITs, with no evidence of an asymmetric effect. The correlation
structure between the markets also shares an asymmetric pattern, where large
negative returns lead to a greater correlation than positive returns.
For the portfolio manager dealing with securitized real estate stock, these results
provide several important pieces of information that may lead to a change in
investment behavior. First, there is clear evidence of intra-day information flows
between both the markets. This information transfer will not only be specific real
estate news, but systematic equity news affecting all stocks in general, leading
to the fact that securitized real estate is part and parcel of the wider equity
offerings available on stock exchanges (at least as a short-run phenomenon).
Although its behavior to more generalized indices may be slightly different,
there is no doubt real estate holding company prices are susceptible to foreign
market influences. Overall daily unconditional correlations between the two
markets might seem small, but the observed volatility spillover effects are,
nevertheless, highly significant. Part of this variation in results will also be due
to compositional differences between the synchronously constructed series and
that of the Datastream series. If the aim is to determine market interaction, care
must be taken that one is comparing similar assets. The choice of index used
also must be made with care.
The U.S. market also seems to exert more influence over the United Kingdom
than vice versa. This is not unexpected, given the sheer size of the U.S. REIT
market relative to the U.K. property market. Furthermore, U.S. economic performance will obviously have a large impact in the smaller sized economy of
the United Kingdom. For the portfolio manager active in smaller property markets around the world, this implies more caution needs to be placed on news
arriving from the United States, as it may well have a significant impact upon
local securitized property prices. This would also support the work of Wilson
and Zurbruegg (2003) showing the significance of the U.S. realty market in
influencing smaller sized property markets. Moreover, given the link between
securitized property and direct property, this may also show through in the
pricing of physical property prices in the long run.

Asymmetric Volatility, Correlation and Returns Dynamics 129

Finally, the observation of asymmetric effects on both volatility and correlations

also highlights one other important investment consideration. Property portfolio
managers will be wise to note the benefits of diversification are possibly smaller
than what would normally be expected, given that during bear markets, when one
would benefit most from diversification, correlations tend to actually increase.
As a note for a future research direction, emphasis could be placed on examining
the impact of various risk factors (such as interest rate movements or general
stock market sentiment) between different markets and how they interact and
vary over time in explaining the time-varying nature of securitized property
market correlations. Whether this be, for example, through orthogonalizing
real estate indices over stock market indices, or parameterizing risk premiums
directly into a model, the results could shed further light on the impact that
foreign property markets may have on domestic securitized realty prices.
We would like to thank four anonymous referees and the journal editor/s for
their invaluable comments and criticisms that helped to improve this article.
We also wish to thank John Glascock for helping to identify U.K. real estate
companies that were used to verify the EPRA information. Finally, we would
like to thank the participants of the European Real Estate Society Conference,
Milan, where this paper was awarded the IPD best property investment paper
(announced at ERES, Dublin 2005).

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