Short sales and price discovery in real estate markets

Indirect real estate (IRE) returns are often shown to lead direct real estate (DRE) returns. Apart from differences in liquidity, transaction costs, and management skills, the DRE market is also less complete than the IRE market – when negative shocks arrive, one can only short IRE (e.g. real estate stocks or REITs), but not DRE. This study investigates if short sales in the IRE market convey any information to the DRE market. Based on high-frequency (weekly) property price data in Hong Kong from 1999 to 2011, we found that short sales in the IRE market led DRE returns, even after controlling for the lagged IRE returns in a VAR model. This suggests that short sales contain private information on the real estate market that is not fully reflected in IRE returns. The spillover effect of short sales, however, weakened after the 2007 global financial crisis because increased uncertainty over the credibility of individual firms made short sales carry more firm-specific information than market-wide news.postprin