Regime switching in the real estate risk premium

Abstract

While a significant amount of research has been undertaken on the risk premium existing in stock markets, very few studies have evaluated the risk premium in property markets. This paper extends the research on risk premium to the market for securitised property in Australia, Japan, the UK and us. A dividend discount model is applied to model the ex ante risk premium implied from the information contained in the price of securitised property shares. A Markov regime-switching model is then used to determine whether changes in the risk premium lead to changes in market prices for these securities. The results show evidence of a cyclical pattern in the risk premium for the securitised property market that can be used by investors when deciding on the best time to buy or sell in this market.