Systematic risk pricing and investment performance of UK and US property markets

Abstract

Purpose – This paper investigates the strategy that a turnaround in the US will portend a turnaround in the UK’s economy and property market. For this strategy to operate, it is assumed that the capital and property markets in and between the two nations are highly integrated with endogenous pricing functions. Design/methodology/approach – Given the endogenous assumptions of the conjectured research statement, tests of integration (or segmentation) between two capital and property markets are conducted. Correlation, tracking error analysis, and a multiple systematic risk factor model are used to test the pricing relationships. The methodological form employs variant macroeconomic variable pricing models (MVM) of alternative combinations of systematic affects operating across and between the national markets. Findings – Pricing integration is noted between the UK and US capital markets, while the property markets are economically and statistically segmented. Opportunities for arbitrage based on different prices/returns for equivalent risk exposures are statistically observed between the UK and US. The effect is that systematic pricing between the two markets cannot be addressed solely by diversification options. This infers a potential for arbitrage (statistically, strategically or in practice) is possible, given that systematic risk exposures between the two markets are not equivalently priced across cyclical phases. In this context it is inferred that the probable measure of pricing differences across the two markets is more than a cyclical lag effect. Practical implications – The paper identifies that global capital markets are integrated, while the property markets between the UK and US are segmented. The complexity of integrated capital markets and segmented property markets produce different returns/prices for comparable systematic risk experienced across the two nations. This supports a potential for statistical arbitrage, if not strategic arbitrage between the two markets. This further supports the rejection of the conjectured turnaround strategy and establishes a basis for research into modelling an international investment/portfolio strategy that can assist in not only pricing expectations, but also in optimizing diversification decisions.Originality/value –The paper delineates the degrees of integration/segmentation in UK and US property and capital markets as a function of systematic risks in changing economic conditions. These differences support the existence of statistical arbitrage and the specification of investment behaviour as a function of differencing pricing expectations. These findings can assist in the formulation of investment and hedging strategies to assist in managing international portfolios subject to cyclical market exposures. This paper contributes to an understanding and foundation for testing the nature and impact of cycles on property investment performance as a function of pricing changes.