Cointegration and Price Discovery between Equity and Mortgage REITs

Abstract

This study analyzes the relationship between equity and mortgage real estate investment trust (REIT) stock prices by performing cointegration tests and causality tests, and estimating an error correction model. Evidence is found that a stable long-run linear relationship exists based on their common reactions to changes in market returns, interest rates and other additional factors. Geweke causality test results indicate a causal relationship running from EREIT stock prices to MREIT stock prices. This may reflect the quicker response of equity REIT stock prices to changes including real estate returns. In addition, the results suggest overall linear dependence (total linear causality) and instantaneous linear feedback between changes in EREIT and MREIT stock prices. The results of the error correction model not only indicate a significant increase in the explanatory power of the model compared with the vector autoregression model but also reveals how the price discovery processes in REIT security markets maintain long-run equilibrium.