Inflation Hedging Properties of REITs in Inflationary Economies An Application of a Markov Regime Switching Model

In this paper, we study the inflation-hedging properties of investments in REITs in Turkey between December 1999 and December 2006. Two main factors motivate the study. First, compared to their counterparts in developed capital markets, Turkish REITs have some important tax incentives as well as flexibility in managing their portfolios. In particular, the law, which governs Turkish REITs, does not impose any dividend payout requirements on them. Second, the Turkish economy provides a rare and good opportunity to test the hedging behaviour of real estate stocks in periods of both high and moderate inflation rates. Turkey has experienced a persistent hyperinflation between late 1970s and the early years of the 21st century, when the inflation has started to change its course for a rather rapidly, suddenly and substantially falling one. We examine the inflation-hedging effectiveness of Turkish REITs under measures of expected and unexpected inflation. Unlike the existing literature which commonly uses Fama Schwert (1977), Fama Gibbons (1982, 1984), and ARMA models to measure expected inflation, we use the Markov regime-switching model proposed by Hamilton (1989) to modelling inflation rate in Turkey. We use a non-linear filter proposed by Hamilton (1989) and then, we employ a smoothing algorithm developed by Kim (1994). Currently we are performing the empirical analysis and expect to report the results in our presentation. We believe this paper will offer the first evidence whether and how a REITís dividend policy may play a role in its inflation-hedging properties under two starkly different inflationary processes.