Journal of Real Estate Finance and Economics, 21:3, 297±313, 2000
# 2000 Kluwer Academic Publishers. Manufactured in The Netherlands.
Conditional Risk Premiums of Asian Real
JIANPING (J. P.) MEI AND JIAWEI HU
This paper uses a multi-factor latent variable model to examine the time variation of expected returns on Asian
property stocks. Using data from 1990 to 1997, we found strong evidence of time-varying risk premium,
suggesting property development based on constant discount rate may underestimate the cost of capital. A further
study using a multi-country model suggests that conditional excess returns of many crisis-stricken economies
appear to move quite closely with each other. This supports the hypothesis that the risk premiums in these Asian
markets move closely over time As a result, they provide a partial explanation of market contagion in the region.
Key Words: contagion, multi-factor model
The Asian ®nancial crisis in 1997 caught many economists, investors and regulators by
surprise. While the crisis could be attributed to a con¯uence of many factors, excessive
real estate speculation, which undermined the countries' banking system, has been
identi®ed as one important factor (see Krugman, 1998 and Malkiel and Mei, 1998).
There was a common perception in Asia before the crisis that real estate investment,
including real estate stocks, is low risk due to the fact that real estate represents tangible
assets. This paper develops a framework for measuring volatility and conditional risk
premiums in real estate stocks. This methodology allows us to relate movements in required
risk premiums to currency, interest rates and real-estate market conditions. We conclude that
real estate investment is actually quite risky in Asia. Moreover, conditional risk premiums
vary substantially over time. As a result, better ®nancial planning is required since many
viable projects planned in the past could fail if market conditions and risk premiums change.
This paper also attempts to shed light on the issue of contagion in Asian real estate
markets. Why do those real estate companies that develop properties in different markets
and that are traded on different stock exchanges tend to rise and collapse together? Using
an integrated capital markets model, we show that one possible explanation is that the
conditional risk premiums of these markets are driven by a similar set of world market
variables. As a result, the conditional equity premiums tend to rise and fall together, which
help contribute to market contagion.
*Author for correspondence: Department of Finance, New York University, 44 West 4th Street, New York, N.Y.
10003. Phone: (212) 998±0354.