Time-Varying Integration of REITs with Stocks: A Kalman Filter Approach

This paper tests the level of market integration between Equity Real Estate Investment Trusts (REITs) and the stock market, using the Korajczyk (1996) market integration index and the Kalman filter methodology. The Kalman-filter technique is employed to capture the dynamic degree of integration between REITs and the stock market. The results show that REITs were highly integrated with the stock market throughout most of the sample period from 1984:1 to 2018:12. Nonetheless, the time varying market integration index displays a number of changes, which coincide with fluctuations in the legislation governing REITs and certain market and economic events. As a robustness check, we also compare the time varying market integration index of REITs with that displayed by Utilities. The results show that Utilities displayed a similar time varying market integration pattern to that of REITs and so indicates that the changes in market integration is not simply a REIT factor but a high yield sector phenomenon. Unlike REITs, from April 2011 Utilities became segmented from the stock market and remained so up to the end of the sample period, even though the static integration index suggested that utility stocks were integrated with the stock market over the whole sample period. Last, results show that the Kalman filter approach is more useful than static models when studying the integration process and so casts strong doubt on the validity of time invariant models to measure market integration.