The Impact of Switching Regimesand Monetary Shocks: An Empirical Analysis of REITs

This paper demonstrates that the effects of unanticipated monetary policy changes (shocks) on real estate investment trust (REIT) returns are asymmetric between the high- and low-variance regimes. A Markov regime-switching model with error correction terms is used to quantify the impact of monetary shocks on seven specialized REIT indices in a sample of daily returns from 1997 to 2008. The relationship between monetary shocks and REIT returns is negative, but this relationship is significant primarily during periods of high variance. Furthermore, monetary shocks have about twice as much effect on REITs as they do on the S&P 500 Index during high-variance regimes. This asymmetric response can be attributed to the Federal Reserve’s recession avoidance tactics, downward price rigidity, and the external financing premium. REITs are an important and independent test case for research into the impact of monetary shocks.