REIT market efficiency through a binomial option pricing tree approach

Abstract

Purpose

The purpose of this paper is to examine the risk neutral and non-risk neutral pricing of Singapore Real Estate Investment Trusts (S-REITs) via comparing the average of the individual ratios (of deviation between expected and observed closing price/observed closing price) with the ratio (of standard deviation/mean) for closing prices via the binomial options pricing tree model.

Design/methodology/approach

If the ratio (of standard deviation/mean) ratio > the ratio (of deviation between expected and observed closing price/observed closing price), then the deviation of closing prices from the expected risk neutral prices is not significant and that the S-REIT is consistent with risk neutral pricing. If the ratio (of deviation between expected and observed closing price/observed closing price) is greater, then the S-REIT is not consistent with risk neutral pricing.

Findings

Capitacommercial Trust (CCT), Capitamall Trust (CMT) and Keppel Real Estate Investment Trust (REIT) have large positive differences between the two ratios (39.86, 30.79 and 18.96 percent, respectively), implying that these S-REITs are not trading at risk neutral pricing. Suntec REIT has a small positive difference of 2.35 percent between both ratios, implying that it is trading at risk neutral pricing. Ascendas REIT has the largest negative difference between the two ratios at −4.24 percent, to be followed by Mapletree Logistics Trust at −0.44 percent. Both S-REITs are trading at risk neutral pricing. The analysis shows that CCT, CMT and Keppel REIT exhibit risk averse pricing.

Research limitations/implications

Results are consistent with prudential asset allocation for viable S-REIT portfolio investing but that not all these S-REITs exhibit strong market efficiency in their pricing.

Practical implications

Pricing may be risk neutral over a certain period but investor sentiments, fear of risks and speculative activities could affect an S-REIT’s risk neutrality.

Social implications

With enhanced risk diversification activities, the S-REITs should attain risk neutral pricing.

Originality/value

Virtually no research of this nature has been undertaken for S-REITS.

Citation

Ho, K.H.D. and Tay, S.J. (2016), "REIT market efficiency through a binomial option pricing tree approach", Journal of Property Investment & Finance, Vol. 34 No. 5, pp. 496-520. https://doi.org/10.1108/JPIF-01-2016-0004