DO INVESTORS PAY ATTENTION TO RARE DISASTER RISK?

EVIDENCE FROM EARTHQUAKE RISK IN JAPANESE REAL ESTATE

INVESTMENT TRUST MARKET

European Real Estate Society 20th Annual ConferenceVienna, AustriaJuly 3-6, 2013

Masaki MoriSeow Eng OngJoseph T. L. Ooi

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Background

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Research Framework

Data & Methods Results ConclusionsIntroduction

Mid Niigata Prefecture

Earthquake, 2004

Great East Japan Earthquake, 2011

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JREIT index return above_4

Background (without extremes)

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Research Framework

Data & Methods Results ConclusionsIntroduction

Research Framework

Data & Methods Results ConclusionsIntroduction

Research question Does earthquake risk perception affect return

of J-REIT stocks?

Do investors alter their attention allocation once earthquake events provoke their fear and awareness toward earthquake?

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Research Framework

Data & Methods Results ConclusionsIntroduction

Motivation from finance literature

Rare events and asset pricing A small probability of very bad things happening

affects asset pricing dynamics (e.g., Rietz, 1988 and Barro, 2005)

Limited attention Investors show limited attention to relevant

information Investors shift attention when faced with greater

uncertainty (e.g., Hirshleifer and Teoh, 2003)

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Research Framework

Data & Methods Results ConclusionsIntroduction

Why earthquake risk? Unpredictable, exogenous, and immediate

6(Japan Meteorological Agency)

Year/Seismic

intensity5+ 6- 6+ 7 Total

2004 11 2 2 1 16 2005 5 2 0 0 7 2006 0 0 0 0 0 2007 2 1 2 0 5 2008 0 1 1 0 2 2009 0 1 0 0 1 2010 0 0 0 0 0 2011 17 4 4 1 26 Total 36 16 10 2 64

Research Framework

Data & Methods Results ConclusionsIntroduction

Why J-REITs? Portfolio level earthquake resistance measure

in semi-annual financial reports (PML: Probable Maximum Loss)

Price informationWe can examine dynamic effects of earthquake

event on prices

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Research Framework

Data & Methods Results ConclusionsIntroduction

Contributions Implications for limited attention finance

literature Hopefully, will shed new light on the impacts of investors’ limited

attention and attention allocation on asset price dynamics

Implications for REIT marketsHow earthquake risk is priced in REITsREIT markets are being developed in some

earthquake prone countries

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Data Study period from Jan. 2004 to Apr. 2012

Earthquake event data from the Japan Meteorological Agency

43 REITs Price data from DataStream and Association

for Real Estate Securitization in JapanPML and financial information from REIT DB

and semi-annual financial reports9

Research Framework

Data & Methods Results ConclusionsIntroduction

Methods Outlier Robust regression (MM-estimation)

Dependent variable○ J-REIT Index total return

Independent variable○ # of earthquake equal to or greater than 5 strong in a month (log)

○ Google score as a robustness check

Sub portfolio analysis (1: low 2: middle 3: high)PML scoreFinancial institution ownershipForeign investor ownership 10

Research Framework

Data & Methods Results ConclusionsIntroduction

Methods Event study

Earthquakes in Japan from Jan. 2004 to April. 2012○ “LARGE” --- 5-strong (26) and 6-weak (9)○ “HUGE” --- 6-strong (3) and 7 (2)

Estimation period = -60 to -30 days Event window = 0 to +10 days Robust test

Abnormal return serial correlationEvent-induced volatility (Kolari & Pynnonen, 2010)

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Research Framework

Data & Methods Results ConclusionsIntroduction

Panel A:Overall J-REIT index (PML: 5.46)

Estimate z -valueConstant 0.015 2.65# of earthquakes -0.019 -2.36 **

Panel B:Low PML portfolio (safe: 2.96) High PML portfolio (dangerous: 8.36)

Estimate z -value Estimate z -valueConstant 0.014 2.27 Constant 0.005 0.67# of earthquakes -0.018 -2.23 ** # of earthquakes -0.010 -1.21

Total return vs. # of quakes

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Research Framework

Data & Methods Results ConclusionsIntroduction

***, **, *, for 1%, 5%, and 10% significance, respectively

Panel C:Low financial (28%) High financial (62%)

Estimate z -value Estimate z -valueConstant -0.002 -0.35 Constant 0.014 2.82# of earthquakes -0.003 -0.32 # of earthquakes -0.021 -2.18 **

Low foreign (11%) High foreign (37%)

Estimate z -value Estimate z -valueConstant 0.013 1.91 Constant 0.002 0.27# of earthquakes -0.014 -1.41 # of earthquakes -0.009 -1.25

Total return vs. # of quakes

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Research Framework

Data & Methods Results ConclusionsIntroduction

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Research Framework

Data & Methods Results ConclusionsIntroduction

Daily abnormal return

Reaction • Gradual price drop from day 2

• Moderate size

• Immediate price drop on day 0 and day 1

• Large size

Recovery • Very slow• Not significant

• Quick from Day 2• Significant

<Large earthquakes (35)> <Huge earthquakes (5)>

Coef. t Coef. trank_pml rank_pml2 0.007 1.05 2 -0.005 -1.003 -0.007 -1.01 3 -0.011 -2.06 **

rank_fin rank_foreign2 -0.007 -1.09 2 -0.002 -0.243 -0.007 -1.04 3 -0.001 -0.21

rank_pml#rank_fin rank_pml#rank_foreign2 2 -0.004 -0.50 2 2 0.009 1.082 3 -0.011 -1.28 2 3 0.026 3.19 ***

3 2 0.008 0.86 3 2 0.008 0.893 3 -0.001 -0.07 3 3 0.018 2.26 **

_cons 0.069 12.76 _cons 0.064 17.34

PML x Fin PML x Foreign

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Research Framework

Data & Methods Results ConclusionsIntroduction

Range of cumulative abnormal return <5+ and 6->

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Research Framework

Data & Methods Results ConclusionsIntroduction

Range of cumulative abnormal return <6+ and 7>

Coef. t Coef. trank_pml rank_pml2 -0.009 -0.42 2 -0.026 -1.553 -0.020 -0.96 3 -0.015 -0.84

rank_fin rank_foreign2 -0.027 -1.28 2 -0.016 -0.883 -0.030 -1.49 3 -0.015 -0.92

rank_pml#rank_fin rank_pml#rank_foreign2 2 0.000 0.01 2 2 0.037 1.482 3 0.003 0.10 2 3 0.049 2.00 **

3 2 0.035 1.28 3 2 0.034 1.293 3 0.029 1.07 3 3 0.030 1.25_cons 0.107 6.15 _cons 0.092 8.43

PML x Fin PML x Foreign

Summary of results Sensitivity of REIT return to gradual change in earthquake

risk perception is high Low PMLHigh financial institution ownership

Rational price reaction after “large” earthquakes

Panic reaction after “huge” earthquakes

Sensitivity of REIT return to quick change in earthquake risk perception is highHigh PMLHigh foreign investor ownership

Research Framework

Data & Methods Results ConclusionsIntroduction

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Implications Probability of rare events happening affects

asset pricing dynamics

Investors shift attention allocation to rare event risk

Different types of investors show different processes of attention allocation to rare event risk

Research Framework

Data & Methods Results ConclusionsIntroduction

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Directions for future research Longer-term effects of huge earthquakes

Demand of tenantsAcquisition/disposition of properties by REITs

Impacts of financial institution ownershipWhy do they respond more slowly than foreign

investors?

Research Framework

Data & Methods Results ConclusionsIntroduction

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