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Volume 38, Number 3, 2016

Time Variation of Expected Returns on REITs: Implications for Market Integration and the Financial Crisis

Yuming Li
California State University, Fullerton


This article uses a conditional covariance-based three-factor pricing model and a REIT index-enhanced four-factor model to examine the time variation of expected returns on REITs over the period 1972-2013. Although expected returns on equity REITs are highly correlated with their own volatility, the covariances of returns on REITs with the stock market premium, small stock premium and value premium subsume the role of the volatility of REITs in explaining expected returns on REITs. The conditional betas of REITs associated with the stock market premium and the value premium, along with the conditional correlation between the two premiums, are more important than the volatility of the stock market or other factors in explaining the time variation of expected returns on REITs, especially during the recent financial crisis. Tests of asset pricing restrictions add further evidence on the integration of the real estate market with the general stock market.

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