Nonlinear adjustment of short-term deviations impacts on the US real estate market

Abstract

This study examines whether nonlinear adjustment of short-term deviations impacts US real estate market returns by applying an exponential smooth transition threshold error-correction model with Generalized Auto Regressive Conditional Heteroscedasticity (GARCH) (ESTECM-GARCH). Empirical results demonstrate that the ESTECM-GARCH captures the dynamics of returns more effectively than the Error-Correction Model (ECM) and Exponential Smooth Transition Error-Correction Model (ESTECM). Consequently, the nonlinear behaviour of returns is driven by momentum noise traders and heterogeneous arbitrageurs in Real Estate Investment Trust (REIT) markets.

Notes

¹ This hypothesis is consistent with the view that the stock market is efficient in the long run but deviates from its fundamental value in the short run due to factors such as noise traders, booms and slumps in the economy, etc. (see, for example, Blanchard and Watson, 1982 and Shleifer, 2000).

² There are two kinds of investors (noise traders and arbitrageurs) in Shleifer and Vishny's model. Noise traders are individuals who have erroneous beliefs about the future returns of risky assets; and further, noise traders react to noisy information, which is irrelevant to future cash flows. Arbitrageurs are investors who have rational expectations about the future cash flows of risky assets and try to exploit the noise traders' incorrect beliefs.

³To save the space, this study does not report the results of stationary tests for the return series on REIT.

⁴The parameters, that is ρ₁ < 0 and ρ₁ + ρ₂ < 0, indicate convergence and stationarity of the returns and both parameters are individually statistically significantly different from 0.

⁵McMillan and Speight (2006) listed alternative possible rationales to explain the nonlinearity behaviour. For the case of an ESTECM model family, homogeneous arbitrageurs when ρ₁ = 0, ρ₂ < 0 (γ is large enough), whereas momentum noise traders, mis-price deepening and heterogeneous arbitrageurs when ρ₁ ≠ (ρ₁ + ρ₂) ≠ 0.