AbstractThe
success of any diversification strategy depends upon the quality of the
estimated correlation between assets. It is well known, however,
that there is a tendency for the average correlation among assets to increase
when the market falls and vice-versa. Thus, assuming that the correlation
between assets is a constant over time seems unrealistic. Nonetheless,
these changes in the correlation structure as a consequence of changes
in the market’s return suggests that correlation shifts can be modelled
as a function of the market return. This is the idea behind the model
of Spurgin et al (2000), which models the beta or systematic risk, of the
asset as a function of the returns in the market. This is an approach
that offers particular attractions to fund managers as it suggest ways
by which they can adjust their portfolios to benefit from changes in overall
market conditions.
In this paper the Spurgin et al (2000) model is applied to 31 real estate market segments in the UK using monthly data over the period 1987:1 to 2000:12. The results show that a number of market segments display significant negative correlation shifts, while others show significantly positive correlation shifts. Using this information fund managers can make strategic and tactical portfolio allocation decisions based on expectations of market volatility alone and so help them achieve greater portfolio performance overall and especially during different phases of the real estate cycle. |