Dependence Analysis of Diversification Benefits of Chinese Real Estate Securities

Abstract

This paper investigates diversification benefits of having real estate securities in investment portfolio by modeling the dependence structures between it and other financial assets in Chinese stock markets, using copula functions. Results first show that it is inadequate to use the linear correlation coefficient as a measure of dependence because of rejection of its normal hypothesis. Then, as an alternative way to model the dependence structure, the optimal copula for each of the two kinds of assets, including real estate, is selected. Copula-based dependence structures are finally computed. The results reveal that real estate securities in Chinese stock markets can provide few, or at the most limited, diversification benefits. To a certain extent, real estate securities are more like stocks than direct investments in real estate. This finding has important implications for both financial investors and financial risk managers.