The effect of rare events on information-leading role: evidence from real estate investment trusts and overall stock markets

The interplay between rare events and their influence on financial markets is a topic of growing interest among investors, researchers, and financial analysts. This has become especially relevant in light of the recent events that have shaken economies around the world. A noteworthy study examines the dynamics between Real Estate Investment Trusts (REITs) and overall stock markets, particularly focusing on how rare events, amplified by phenomena like the COVID-19 pandemic, can influence market information efficiency.

The SPDR S&P 500 ETF (SPY) and iShares US Real Estate ETF (IYR) serve as crucial indicators for the overall performance of stock markets and REITs in the United States, respectively (Bae and Kim, 2020; Kownatzki et al., 2023). SPY is the oldest and most recognized ETF tracking the US stock market, providing an accurate reflection of market performance. In contrast, IYR has established itself as a benchmark for the US REIT market, following the Dow Jones US Real Estate Index that encapsulates the performance of various REITs (Curcio et al., 2012; Ryu et al., 2021).

The period under study spans from December 1, 2018, to June 30, 2021, encompassing a critical timeframe that includes the declaration of the COVID-19 pandemic by the World Health Organization. This context offers a unique lens to assess the relationship between REITs and the broader stock market, mainly how exogenous shocks influence market behaviors (Onali and Mascia, 2022; Yang et al., 2023).

Data analysis reveals substantial insights into the characteristics of returns associated with the SPY and IYR ETFs. The descriptive statistics indicate that the return distribution of IYR is more volatile compared to SPY when considering essential metrics such as the minimum-maximum range and standard deviations. Such volatility can be indicative of investor behavior in fluctuating market environments (Wen and Yang, 2009; Yi et al., 2022). Moreover, both return distributions exhibit negative skewness, signaling a general risk-averse attitude prevalent among investors, a sentiment that has only intensified during volatile periods.

The study employs a variety of methodologies to investigate the weak-form market efficiency hypothesis and assess information flows between the two assets. Primarily, the Variance Ratio Test (VRT) has been utilized. This test helps to determine whether the price series behaves like a random walk—a foundational assumption in modern finance—and provides insights into the market’s informational efficiency (Aumeboonsuke and Dryver, 2014). The results suggest that both return series deviate considerably from a Gaussian distribution, which raises questions about the robustness of traditional analysis techniques and highlights the necessity for employing alternative methodologies that accommodate anomalies in market behavior.

Another vital methodological approach integrated into the study is Transfer Entropy (TE), which offers an advanced framework for measuring information flow between the SPY and IYR assets. By employing Shannonian TE and Rényian TE, the research captures the nonlinear interactions and asymmetries that often accompany rare events and tumultuous market conditions (Yi et al., 2021; Jo et al., 2023). The findings illustrate not only how information is transmitted between these two markets but also how occasional extreme events exert a disproportionate impact on investor sentiments and market movements.

The outcomes of this study lend themselves to understanding the broader implications of market structure and behavior. Specifically, the Adjusted Market Inefficiency Magnitude (AMIM) serves as a barometer for gauging the efficiency of the market over time, taking into account the autocorrelation of returns (Le Tran and Leirvik, 2019). The observations suggest that during periods of heightened volatility, particularly during events like the pandemic, inefficiencies in the market emerge, implying that investors may struggle to adapt swiftly to changing circumstances.

Additionally, the research underscores the inherent risks associated with investing in REITs relative to broader stock markets. The heightened volatility associated with REITs could, in theory, offer opportunities for discerning investors, yet it also poses significant risk in times of economic uncertainty. This relationship encourages investors to consider diversification within their portfolios to mitigate potential adverse effects stemming from unexpected events.

Ultimately, the study contributes to the evolving dialogue surrounding market behavior under stress. As participants in the market navigate uncertain times, understanding the impact of rare events on information flow and market efficiency becomes increasingly essential. The nuances revealed through this study challenge the traditional paradigms of market analysis and the assumptions underlying stock and REIT interactions.

In conclusion, the intricate relationship between rare events and market dynamics calls for more granular analysis and innovative methodologies. Through the lens of the COVID-19 pandemic, this research highlights not only the vulnerability of financial markets to exogenous shocks but also the potential pathways for informed decision-making in investment strategies—especially when navigating the sometimes-chaotic landscape of REITs and the stock market at large. Investors would do well to heed these findings as they craft their approaches to managing risk in a world that’s ever-changing.

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