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Inflation Hedging Characteristics of Chinese Real Estate
Market1
Chu Yongqiang
(National University of inga!ore 11"#$$%
&'stractNowadays Chinese real estate market is developing
very fast, more and moreindividuals, as well as institutional
investor are considering investing in real estate. Forthis purpose,
we must know the return characteristics of real estate, as compared
withthe inflation rate. In this article, we study the inflation
hedging characteristics ofChinese real estate market following the
OLS methodology developed y Fama andSchwert!"#$$%. &nd we use
&'I(& model to first decompose the inflation rate
toe)pected and une)pected inflation rate. *he results of OLS do not
provide evidence tosupport the hypothesis that real estate acts as
effective inflation hedge. &nd we also usecointegration test to
study the long term relationship of real estate market and
inflation,then the +ranger causality test is carried out to see the
causality relationship. &gain wefind no evidence of long term
hedge aility of Chinese real estate. owever thecausality test do
show that the inflation leads real estate return.)ey *ordsChinese
'eal -state (arket, Inflation edging, -)pected Inflation 'ate
ection I Introduction
*he relationship etween real estate return and inflation has een
suected to e)tensiveempirical research since the seminal paper y
Fama and Schwert !"#$$%. *he Chinese (arket is ofinterest ecause of
the following reasons,. First Chinese real estate market is an
emerging, highlyspeculative market, which is e)pected to show much
different characteristics compared with themature market. Second,
the inflation hedging characteristics in China has not een studied.
*hird,more and more attention has een made aout the direct
investment on real estate, so it isimportant to study the
investment return with respect to the corresponding inflation
rate.
In this article, we will firstly use the conventional OLS
methodology to test the inflationhedging aility of real estate
return ased on the /uarterly data from "##012332. &nd then
acointegration test ased on the e)tended yearly data will e done to
study the long termrelationship and +ranger Causality test will
also e employed to study the causality relationshipetween real
estate return and inflation rate.
*he rest of this article will e organi4ed as follows5 Section II
will provide a rief literatureview of inflation hedging
characteristics of various assets, especially those of real estate6
thetheoretical framework will e given in Section III6 *he
methodology of various model mentionedaove will e discussed in
Section I76 section 7 will riefly descrie the data for this
article6 theresult of various models will e given out in section
7I6 section 7II concludes the article.
ection II +iterature ,ie-
*he empirical study of the relationship of asset return and
inflation was firstly done y Famaand Schwert !"#$$%. In their
seminal paper, the return of 8S treasury ills, long term
treasuryonds, private residential real estate, human capital and
common stocks are studied. *hey usedconventional OLS method to
study the inflation hedging characteristics of these assets, and
thenominal return of *reasury ill will used as the appro)imation of
the e)pected return. *hey haveshown that only private residential
real estate is a complete hedge against oth e)pected and
"C-N-*9Correspondence &ddress5 :epartment or 'eal -state,
School of :esign and -nvironment, National 8niversity ofsingapore,
; &rchitecture :rive, Singapore, ""$
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une)pected inflation, while government det instruments are only
complete hedge againste)pected inflation, and human capital is at
est a partial hedge against e)pected and une)pectedinflation, and
common stocks are shown to e negatively related to oth e)pected and
une)pectedinflation.
>arkham, ?ard and enry !"##0% e)amined inflation hedging
characteristics of 8@ property.*hey used an alternative method to
decompose the inflation rate, which is &'I(& !", ", A%.
*hey
also used cointegration and causality analysis to test the
long1term relationship. *hey have shownthat in the short run,
changes in e)pected and actual inflation affects returns to direct
real estate,and that the property return and inflation are
cointegrated in the long run.
+at4laff !"##;% used another decomposition method of
&'I(&!",3,A% and studied therelationship etween inflation
and e)cess return.
Stevenson and (urray !"###% e)amined the inflation hedging
aility of Irish real estate,using oth the conventional OLS and
cointegration analysis. is results show that Irish real estatedoes
not provide a good hedge against inflation which differs from the
maority of empiricalevidence from other real estate markets.
Stevenson !"###% showed that although the conventional OLS
models provides littleevidence of a consistent and stale
relationship, the cointegration results, especially those
otainedfrom the -ngle1+ranger procedure, provide strong evidence to
support the hypothesis that thehousing market return and inflation
are cointegrated.
Stevenson !2333% focused on the long term relationship of
inflation and housing market,which shows that the cointegration
test provides strong evidence that housing and inflation share
acommon long term trend, while *arert !"##0% focused on the
inflation hedging characteristics ofvarious property types.
ection III .heoretical /ra0e-ork
Irving Fisher !"#A3% pointed out that the nominal interest rate
can e e)pressed as the sum of ane)pected real return and an
e)pected inflation rate. ?hen this is applied to asset return, it
statesthat the e)pected nominal return contain market assessment of
e)pected inflation rate. So in anefficient market, the price of any
asset will e determined such that the e)pected nominal return
on
the asset from "t
tot
is the sum of the appropriate e/uilirium e)pected real return
and the estpossile assessment of the e)pected inflation rate from
"t to t, which is5
" " "! % ! % ! %
t t tE R E r E I
= +
R1nominal returnr- real rate of returnI1 inflation rate
&nd again Fisher suggests that the e)pected return is
determined y real factors as the realand monetary sectors of the
economy are largely independent. *his is made it convenient for us
tostudy the return1inflation relationship without introducing a
complete general e/uilirium modelfor e)pected real return.*hus we
otain another form of !"%5
"! %
t t t t R E I
= + +
!2% can e estimated y OLS. &side from the e)pected return,
we are also interested in theunanticipated component of inflation,
which can e otained y5
" "! % ! ! %%
t t t t t t t R E I I E I
= + + +
&s ased on FisherBs model, all assets should have a
coefficient ".3 = , and when ".3 = , we
say that the asset provides complete hedge against e)pected
inflation, and ".3 = suggests that itprovides complete hedge
against une)pected inflation.
Section I75 (ethodology
1 2+ Regression Model
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>ased on the analysis aove, we will use OLS to estimate !A%,
which is also suggested y
Fama and Schwert !"#$$%. I will test whether or is statistically
indistinguishale from unity.If oth coefficients are e/ual to ",
then the real estate is a complete hedge against inflation. &nd
in!A%, the constant can e interpreted as the e/uilirium real rate
of return.
?hen testing the inflation hedging aility, the pro)y of
inflation rate is an important factor. InFama and Schwert, they
used *reasury ill return a pro)y. ?hile in China, the *reasury ill
ishighly regulated y the government, and is illi/uid, so we cannot
use the return of *reasury ill asappro)imation of e)pected
inflation. Instead I use &'I(& model to otain the e)pected
inflationas +at4laff !"##;% and >arkham, ?ard and enry !"##0%
did.
&s mentioned y many literatures, this methodology suggested
y Fama and Schwert has aig prolem in that it does not consider the
stationarity of time series data, which may result inspurious
regression. !Sing 2333 !a%, Sing 2333!%,*arert "##0%. In this
article, the stationarity ofthe time series data of real estate
return and inflation will e tested to insure that there is
nospurious regression.
3 Cointegration
?hile OLS has een widely utili4ed as the classical method in the
e)amination of inflationhedging aility of asset, more and more
literature argue that the OLS regression may not e
suitale when the asset is illi/uid, especially real estate.
Cointegration method is useful in thiscase to study the long term
return1inflation relationship even though the short term
relationshipmay vary. *his study follows the two step procedure
proposed y -ngle and +ranger !"#$%.Initially real estate return and
inflation series are tested for stationarity using augmented
:ickey1Fuller test !&:F%5
"
"
J
t t j t j
j
y y y
=
= +
&nd the Cointegration test is ased on that the series at
level is I!"%, the residual of theregression then is again tested
for stationarity y &:F, if the residual is stationary, then the
twoseries are cointegrated which means that they have long term
relationship.
t t ty x = + +
&nd t is suect to the &:F test.
4 5ranger Causality .est
&fter testing the cointegration, +ranger causality test will
e used to test causality etweeninflation and real estate return to
determine which one causes the other. If the variales are
notcointgrated in the levels, then5
" "
" "
J J
t i t i i t i t
i i
y y x u
= =
= + + +
2 2
" "
J J
t i t i i t i t
i i
x y x v
= =
= + + +
If the variales are cointegrated, then the +ranger
causality1-rror Correction model !+C1-C(% must e used5
" " ", "
" "
J J
t i t i i t i t t
i i
y y x z u
= =
= + + + +
2 2 ", "
" "
J J
t i t i i t i t t
i i
x y x z v
= =
= + + + +
*he term "tz is added to reflect the long1term relationship. *o
test the causality, the F test
will e used to test the oint significance of i .
ection , 6ata 6escri!tion
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*he actual inflation rates of various cities are calculated from
the CDI, which is availalefrom :atastream. *o decompose the
inflation rate to e)pected and une)pected inflation,
&'I(&!",3,A% model was used as suggested y +at4laff !"##;%.
*he statistical properties of inflation rateof these cities are
shown from tale " to tale ;.
Table 1Inflation Rate of Beijing
8I' -I' &I' (ean 13.3330$3 13.33
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Table 2Inflation Rate of Shanghai
8I' -I' &I'
(ean 1;.0;-13< 13.33
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From these tales we can see that over the studied years, these
cities e)perienced a lowinflation period or even deflation, which
is accompanied y the high growth rate of Chinese macroeconomy.
&nd more the inflation rate is of little volatility which can e
seen from the standarddeviation.
*he data of real estate return is otained from Chinese 'eal
-state Inde) !C'-I%. *his inde)contains the /uarterly real estate
price inde) of maor Chinese cities since "##eiing, Shen4hen,
Chengdu, which can represent the north, south, eastand west part of
China. In each city, oth residential property, commercial property
and officeproperty are e)amined. &s mentioned earlier, the
&:F test must e done to test the stationarity.
From the tale < to tale , we can see that most of the series
are stationary at the level ofut as the short termdevelopment of
Chinese real estate market and the availaility of data, this is
what we can do est.!In the tales,'D1return of real estate,
''D1return of residential property, 'OD1return of officeproperty,
'CD1return of commercial Droperty, -I'1 the e)pected inflation
rate, 8I'1une)pectedinflation rate.GG significant at ", G
significant at
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-I' 1
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Table 1,. The )*S Result of Shanghai Real +state Ma!et
Intercept -I' 8I' &'!"% F1statistic '2!&dusted%
'D 3.333$ 13.32#A$ 13.3A0 3.#0$GG A
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oth e)pected and une)pected inflation rate in those developed
countries.¬her finding of the result is that almost in all
cases the lagged term is significant at
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Table 1%. Unit Root Test of the Regession Residual
Level
:F!no lag% 1".#&:F !" lag% 1"."0
&:F !; lag% 1"."2
*his shows that the two series are not cointegrated ecause the
unit root test show elowcritical value statistic even for :F test.
*herefore it can e concluded that there is no evidence thatthe
Chinese real estate market is a long term hedge against inflation.
&nd the result is the samewith *arert !"##0% and Stenvenson and
(urray !"###%, however it is contrary to the findings of>arkham,
?ard and enry !"##0%, (atysiak et al !"##0% and Stevenson
!2333%.
&s there is no evidence of cointegration of real estate
return and inflation rate nationwide, anerror1correction term is
not re/uired in the +ranger causality model. *he result of the
+rangercausality test is listed elow5
Table 1&. ange Causalit Test of Real +state Retun and
Inflation
Null ypothesis5F1Statistic Droaility
I' does not +ranger Cause '-*8'N 3.#$#A2 3.;"0;
