Random Walks and the Cointegration of the ACLI and NCREIF

Abstract

Do NCREIF returns influence commercial mortgage underwriters when they adjust capitalization rates? Are the ACLI capitalization series and the NCREIF return series cointegrated at the national and the smaller geographic sub-division levels? This research uses a two-step procedure to test for cointegration. First, the Phillips–Perron unit-root procedure must show that each series is a unit-root random walk. Previous research usually has assumed that these series are random walks, with the implication that the commercial mortgage market is efficient. Second, the Phillips–Ouliaris test of the residuals of a function of the two series determines the possibility of cointegration. At the national level and for the Northeast and Pacific regions the two series are random walks and cointegrated. In other geographic sub-divisions, neither or only one series is a random walk and therefore the data does not support a relationship. The lack of functional relationships in four of the six smaller geographic regions suggests that underwriters are not obtaining the NCREIF information or are ignoring it. The lack of random walks with the implication about capital-market efficiency invites further research.