Review of Quantitative Finance and Accounting, 16, 103–115, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
The Relationship Between REITs Returns and Inﬂation:
A Vector Error Correction Approach
Department of Finance, Yuan Ze University, Taoyuan, Taiwan
RAYMOND W. SO
Department of Finance, Chinese University of Hong Kong, Shatin, Hong Kong
Abstract. Previous studies show that REITs returns and inﬂation are negatively related. This paper reexamines
this perverse inﬂation hedge phenomenon by investigating the relationship among REITs returns, real activities,
monetary policy and inﬂation through a Vector Error Correction Model. Empirical results show that inﬂation does
not Granger-cause REITs returns and that REITs returns signal changes in monetary policy. The observed negative
relationship between REITs returns and inﬂation is merely a proxy for the more fundamental relationship between
REITs returns and other macroeconomic variables.
Key words: perverse inﬂation hedge, real estate investment trusts, VECM
JEL Classiﬁcation: C32, G12
The effectiveness of real estate in hedging inﬂation has been extensively studied and dis-
cussed in the literature. In general, there is a consensus that unsecuritized real estate is
able to hedge against inﬂation (e.g., Sirmans and Sirmans, 1987; Brueggeman, Chen and
Thibodeau, 1984; Miles and McCue, 1984; Hartzell, Hekman and Miles, 1987; Gyourko
and Linneman, 1988; Bond and Seiler, 1998). Nevertheless, extant literature have also doc-
umented a negative relationship between common stock returns and inﬂation (e.g., Jaffe
and Mandelker, 1976; Bodie, 1976; Nelson, 1976; Fama and Schwert, 1977). Being se-
curitized forms of real estate, whether Real Estate Investment Trusts (REITs) are able to
hedge against inﬂation becomes an interesting question. On the one hand, REITs should
not be able to hedge inﬂation due to their common stock characteristics. On the other, they
should be inﬂation hedges due to their operation in real estate. However, empirical evi-
dence tends to show that REITs are perverse inﬂation hedges (e.g., Goebel and Kim, 1989;
Park, Mullineaux and Chen, 1990; Chen, Hendershott and Sanders, 1990; Liu, Hartzell and
Correspondence to: Raymond W. So, Department of Finance, Chinese University of Hong Kong, Hong Kong.
Tel: +(852) 2609-7640; fax: +(852) 2603-6586.