Jarl Kallberg, Crocker H Liu
ABSTRACT
One of the most controversial topics in modern financial economics
is 'excess volatility': the notion that stock prices move too much to be
explained by fundamental economic and firm-specific factors. This research
measures the extent of excess volatility in a special class of
equities: real estate investment trusts (RIETs). The structure of REITs,
specifically, the constraints on dividend payout, the passive approach
to asset management and the detailed data available on REIT composition,
make them ideal for this investigation. The tests are conducted using the
Shiller-West variance bounds methodology and by estimating the volatility
of the underlying assets. We find that despite the absence of dividend
smoothing behavior, REITs exhibit approximately the same level of excess
volatility as determined in Shiller's work. This finding of excess volatility
is confirmed in the second part of our analysis and suggests that dividend
smoothing cannot explain excess volatility. Furthermore, it suggests that
prices of securitized real estate vehicles like REITs follow a stochastic
process that is very different from the process driving the underlying
real assets.
Kallberg: (212) 998-0339 jkallber@strern.nyu.edu
Liu: (212) 998-0353 cliu@stern.nyu.edu
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