Anthony B. Sanders

Risk and Return on Real Estate: Evidence from Equity Reits

We analyze monthly returns on an equally-weighted index of 18 to 23 equity (real property) real estate investment trusts (REITs) that were traded on major stock exchanges over the 1973-87 period. We employ a multifactor Arbitrage Pricing Model using prespecified macroeconomic factors. We also test whether equity REIT returns are related to changes in the discount on closed-end stock funds, which seems plausible given the closed-end nature of REITs. Three factors, and the percentage change in the discount on closed-end stock funds, consistently drive equity REIT returns: unexpected inflation and changes in the risk and term structures of interest rates. The impacts of these variables on equity REIT returns is around 60 percent of the impacts on corporate stock returns generally. As expected, the impacts are greater for more heavily levered REITs than for less levered REITs. Real estate, at least as measured by the return performance of equity REITs, is less risky than stocks generally, but does not offer a superior risk-adjusted return and is not a hedge against unexpected inflation.

The Variation of Economic Risk Premiums in Real Estate Returns

We examine the predictable components of returns on stocks, bonds, and real estate investment trusts (REITs). We employ a multiple-beta asset pricing model and find that there are varying degrees of predictability among stocks, bonds, and REITs. Furthermore, we find that most of the predictability of returns is associated with the economic variables employed in the asset pricing model. The stock market risk premium is highly important in capturing the predictable variation in stock portfolios, and the bond market risk premiums (term and risk structure of interest rates) are important in capturing the predictable variation in bond portfolios. For REITs, however, both the stock and bond market risk premiums capture the predictable variation in returns. REITs have comparable return predictability to stock portfolios. We conclude that there is an important economic risk premium for REITs that are not captured by traditional multiple-beta asset pricing models.

List Prices, Sale Prices and Marketing Time: An Application to U.S. Housing Markets

Many goods are marketed after first stating a list price, with the expectation that the eventual sales price will differ. In this article, we first present a simple model of search behavior that includes the seller setting a list price. Holding constant the mean of the buyers’ distribution of potential offers for a good, we assume that the greater the list price, the slower the arrival rate of offers but the greater is the maximal offer. This trade-off determines the optimal list price, which is set simultaneously with the sellers reservation price. Comparative statics are derived through a set of numerical sensitivity tests, where we show that the greater the variance of the distribution of buyers’ potential offers, the greater is the ratio of the list price to expected sales price. Thus, sellers of atypical goods will tend to set a relatively high list price compared with standard goods. We test this hypothesis using data from the Columbus, Ohio, housing market and find substantial support. We also find empirical support for another hypothesis of the model: atypical dwellings take longer to sell.

Thy Neighbor's Mortgage: Does Living in a Subprime Neighborhood Affect One's Probability of Default?

This paper focuses on the potential externalities associated with subprime mortgage origination activity. Specifically, we examine whether negative spillover effects from subprime mortgage originations result in higher default rates in the surrounding area. Our empirical analysis controls for loan characteristics, house price changes, and alternative loan products. Our results indicate that after controlling for these characteristics, the concentration of subprime lending in a neighborhood does not lead to greater default risks for surrounding borrowers. However, we do find that more aggressive mortgage products (such as hybrid-ARMs and low/no documentation loans) had significant negative spillovers on other borrowers. Stated differently, the aggressive alternative mortgage designs were more toxic to the housing and mortgage market than previously believed.

On the Intertemporal Behavior of the Short-Term Rate of Interest

This paper examines the intertemporal behavior of the short-term rate of interest in a mean-reverting model (Vasiceks elastic random walk model). Using the Goldfeld-Quandt switching regressions technique, we show that the mean-reverting model switched regimes three times over the sample period (March 1959 to December 1985) and that two of these switches coincide with the 1979 and 1982 changes in Federal Reserve monetary policy on interest rates. Parameter estimates prove to be unstable over the sample period. There is evidence of slow mean reversion over the entire sample period; yet significant mean-reversion emerges only in the 1979n1982 regime.

Does Regulatory Capital Arbitrage or Asymmetric Information Drive Securitization

Banks face the choice of keeping loans on their balance sheet as private debt or transforming them into public debt via asset securitization. Securitization transfers credit and interest rate risk, increases liquidity, augments fee income, and improves capital ratios. Yet many lenders still choose to retain a portion of their loans in portfolio. An open research question is whether lenders exploit asymmetric information to sell riskier loans into the public markets or retain riskier loans in response to regulatory capital incentives (regulatory capital arbitrage). We examine this question empirically using micro-level data and find that securitized mortgage loans have experienced lower ex-post defaults than those retained in portfolio, providing evidence consistent with the latter explanation for securitization.

Pricing Life-of-Loan Rate Caps on Default-Free Adjustable-Rate Mortgages

A model is developed and utilized in this paper to value a life-of-loan interest-rate cap on an ARM that reprices monthly. The value of the cap is seen to depend importantly on both the slope of the term structure and the variance of the 1-month rate. However, the cap value is not sensitive to the source of the slope of the term structure - what precise combination of interest-rate expectations and risk aversion determined the slope. This insensitivity is fortunate because of the great difficulty of knowing at any point in time why the term structure is what it is.Given the variation in the slope of the term structure and the variance of the 1-month rate that occurred over the 1979-84 period, the addition to the coupon rate on a 1-month ARM that lenders should have charged for a 5% life-of-loan cap has ranged from 5 to 40 basis points. Copyright American Real Estate and Urban Economics Association.

Determinants of the Value of Call Options of Default-Free Bonds

The fundamental determinants of the value of an option on a bond are the level and slope of the term structure and the level of interest-rate uncertainty. Competing models that have been developed to price bond options produce similar estimates as long as those models are conditioned on similar values for the fundamental determinants. This result is established for simple options with known closed-form solutions and for more complex options that require numerical methods for evaluation. The finding is confirmed for a wide range of economic conditions, and it is shown to be robust with respect to the number and nature of factors that generate interest-rate movements. Copyright 1990 by the University of Chicago.

A General Derivation of the Jump Process Option Pricing Formula

The following paper presents a general derivation of the jump process option pricing formula. In particular, a general jump process formula is derived via an analysis of the limiting behavior of the binomial option pricing formula. In deriving the formula, a very simple central limit theorem known as Poissons Limit Theorem is applied. The simplicity of the analysis allows the establishment of precisely the connections between the specification of the underlying binomial stock return process and the specific form of the corresponding continuous-time jump process formula. Several examples are provided to illustrate these connections.

Servicers and Mortgage-Backed Securities Default: Theory and Evidence

We study conflicting incentives of the master and special servicers in handling troubled loans in a Commercial Mortgage‐Backed Securities deal and how the frictions between the interests of the two servicers might be diminished if the master and special servicing rights are held by the same firm. We show that concentrating both servicing rights in one firm reduces the likelihood that a defaulted loan terminates in foreclosure.