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JPIF
34,5
496
Received 18 January 2016
Revised 15 May 2016
Accepted 17 May 2016
Journal of Property Investment &
Finance
Vol. 34 No. 5, 2016
pp. 496-520
© Emerald Group Publishing Limited
1463-578X
DOI 10.1108/JPIF-01-2016-0004
REIT market efficiency through
a binomial option pricing
tree approach
Kim Hin David Ho and Shea Jean Tay
Department of Real Estate, National University of Singapore, Singapore
Abstract
Purpose – The purpose of this paper is to examine the risk neutral and non-risk neutral pricing of
Singapore Real Estate Investment Trusts (S-REITs) via comparing the average of the individual ratios
(of deviation between expected and observed closing price/observed closing price) with the ratio
(of standard deviation/mean) for closing prices via the binomial options pricing tree model.
Design/methodology/approach – If the ratio (of standard deviation/mean) ratio Wthe ratio
(of deviation between expected and observed closing price/observed closing price), then the deviation
of closing prices from the expected risk neutral prices is not significant and that the S-REIT is
consistent with risk neutral pricing. If the ratio (of deviation between expected and observed closing
price/observed closing price) is greater, then the S-REIT is not consistent with risk neutral pricing.
Findings – Capitacommercial Trust (CCT), Capitamall Trust (CMT) and Keppel Real Estate Investment
Trust (REIT) have large positive differences between the two ratios (39.86, 30.79 and 18.96 percent,
respectively), implying that these S-REITs are not trading at risk neutral pricing. Suntec REIT has a
small positive difference of 2.35 percent between both ratios, implying that it is trading at risk neutral
pricing. Ascendas REIT has the largest negative difference between the two ratios at −4.24 percent, to be
followed by Mapletree Logistics Trust at −0.44 percent. Both S-REITs are trading at risk neutral pricing.
The analysis shows that CCT, CMT and Keppel REIT exhibit risk averse pricing.
Research limitations/implications – Results are consistent with prudential asset allocation for
viable S-REIT portfolio investing but that not all these S-REITs exhibit strong market efficiency in
their pricing.
Practical implications – Pricing may be risk neutral over a certain period but investor sentiments,
fear of risks and speculative activities could affect an S-REIT’s risk neutrality.
Social implications – With enhanced risk diversification activities, the S-REITs should attain risk
neutral pricing.
Originality/value – Virtually no research of this nature has been undertaken for S-REITS.
Keywords Singapore, S-REITs, Binomial option pricing model, Non-risk neutral pricing,
Risk averse pricing, Risk neutral pricing
Paper type Research paper
Introduction
As the Singapore Real Estate Investment Trust (S-REIT) has been a vital emerging
sector in Singapore’s capital market over the past decade, it is imperative to understand
its scope with its inherent uncertainty, both quantifiable and unquantifiable. S-REITs
are deemed to have minimal risks to investors, owing to its immense capital size and
strict government regulations on leverage limits and corporate governance
requirements. From the 2009 global financial crisis, the historical S-REIT prices fell
sharply across the sector. Therefore, S-REITs do have their share of risks and investors
should make informed decisions in S-REIT investing. An analysis of S-REIT pricing
enables investors to better define S-REIT market uncertainty in extent and in time.
The binomial option pricing model (Cox et al., 1979), based on the risk-neutral
probability concept, makes use of a decision tree to represent uncertainty, and the
model enables us to investigate how uncertainties can impact the S-REIT investment
decisions. Case et al. (1991) and Shiller (1989) reiterate that the value of the real estate REIT market
investment trust (REIT) shares outstanding is limited by the value of direct real estate efficiency
owned by the REITs. Therefore, the shorting of shares in REITs can never be a means
of hedging real estate risk for a majority of REIT and real estate owners.
Generally and as the S-REITs are quite similar to domestic common stocks
(Chiang and Lee, 2002), an S-REIT option should have similar characteristics to
standard financial options. Such an option can be priced via adopting the existing 497
option pricing approach. The optimal time to invest in an S-REIT should be analogous
to the optimal time to exercise a financial call option. By synthesizing the
characteristics of the options within an investment opportunity in the S-REIT, and by
adopting an appropriate option pricing model, it should be possible to test the efficient
pricing of S-REITs.
This paper examines S-REIT pricing, in particular, its expected (e) pricing that is
consistent with the risk-neutral concept and its corresponding deviation from the
observed closing (o) pricing. The paper can evaluate whether or not the S-REITs appeal
to the risk-averse, risk-taking or risk-neutral investors. As the binomial option pricing
tree model is based on a risk-neutral concept (Cox et al., 1979), this paper makes use
of the decision tree to model the S-REIT expected price estimates (e) in successive,
forward, single step, multi periods. The paper offers an in-depth examination of
several issues:
• to investigate the risk neutrality of S-REIT pricing using the expected (e) pricing
that is consistent with the risk-neutral concept (via adopting the binomial option
pricing tree model), and the corresponding deviation from the observed closing
(o) pricing;
• to evaluate whether or not the S-REITs exhibit risk-averse, risk-taking or risk-
neutral behavior from the investors’ view point; and
• to examine the possible reasons resulting in such risk-averse, risk-taking or risk-
neutral behavior, pertaining to the portfolio and asset allocation of the S-REITs.
This paper should provide meaningful insights on how the selected S-REITs will
appeal to the risk-averse, risk-taking or risk-neutral investors. The paper enables
investors to better understand the inherent S-REIT risks, and to facilitate more
effective, viable investment decisions and S-REIT portfolio diversification. The paper
also enables a more precise model prediction for a particular S-REIT’s pricing
performance. Hence, the paper consists of several sections with the first section
providing an overview of the importance of taking a closer look at the inherent risks of
the S-REIT and the paper’s aims. The next (second) section discusses the related
literature on the binomial option pricing tree model for financial options and real
options. The third section discusses the study approach while the fourth section covers
the data collection and treatment. The fifth section discusses the results and findings
while the sixth section concludes the paper.

The related literature

The literature comprehensively discusses the binomial option pricing tree model for
financial options, developed by Cox et al. (1979). It is an option valuation model, which
involves a simple discrete time binomial tree, and it assumes that a common stock price
follows a multiplicative binomial process over discrete time periods. It reduces the
possibilities of price changes while removing the possibility for arbitrage, and it
JPIF assumes a perfectly efficient market. It also recognizes entrepreneurial flexibility and
34,5 risk explicitly. The binomial model takes a risk neutral approach to security price
valuation. The model assumes that the underlying security or common stock prices can
only either increase or decrease with time until the option expires. It will be used as a
risk-neutral measure in this paper for the pricing of S-REITs. Briefly and as
subsequently depicted in Figures 1 and 2, the model’s rate of return on the common
498 stock over each period can have two possible values with each resulting from an
upward or downward movement: (u−1) with risk neutral probability q or (d−1) and
with the risk neutral probability of (1−q). The current common stock price S, at the end
of a period will either be uS or dS. There are basically two types of option pricing – the
call option and the put option. An American option is an option contract that can be
exercised at any point throughout the life of the contract at the discretion of the option
buyer. This is in contrast to European options, which can only be exercised at
expiration. This paper will focus on the American option as it is appropriate to an
S-REIT, where the buyer can sell off his S-REIT at any point in time.
A call option is a financial instrument that gives the buyer the right but not an
obligation to buy a set quantity of a security at an agreed strike price at some point in
time on or before expiration. When the buyer decides to exercise the option, the buyer
can buy the security at the agreed upon strike price even if the security’s market price
at that point of time is above the strike price. This paper will focus on the call option

1
Figure 1.
0
Number of S-REITs 1986 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
listed over the years
Source: Authors (2014, 2016)

Su = u × S0
q

S0

Figure 2. 1–q
The 1-period Sd = d × S0
binomial t=0 t=1
option model
Source: Authors (2016)
method as it envisages a well-performing S-REITs market in Singapore, and that there REIT market
is expected growth in S-REIT stocks such that investors should be able to sell off their efficiency
S-REITs at a higher price than the purchase price. A put option is a financial
instrument that conveys the buyer the right but not an obligation to sell a specified
quantity of a security at an agreed strike price on or before an agreed upon expiration
date. If the option buyer exercises the put option, he can sell the underlying security (or
common stock) at the agreed upon strike price, even if the market price for that security 499
at the point of exercise has fallen below the strike price.
Grissom et al. (2012) refer to the beta coefficient of the market model that has gained
wide acceptance as a relevant risk measure in portfolio and common stock analysis.
An essential prerequisite for deploying beta to assess future portfolio risk and total return
(TR) is a reasonable degree of predictability for future time periods. Such a prerequisite of
modern capital market theory should enable portfolio managers to predict future beta
coefficients for meaningful applicability. In addition, Grissom et al. (2012) have noted that
pricing integration occurs between the UK and US capital markets while their direct real
estate markets are economically and statistically segmented. Opportunities for arbitrage
based on different prices and TRs for equivalent risk exposures are statistically observed
between the UK and USA. It is explicit that systematic pricing between the two markets
cannot be addressed solely by diversification options. The potential for arbitrage
(statistically, strategically or in practice) is possible, given that systematic risk exposures
between the two markets are not equivalently priced across cyclical phases. In this
context, it is inferred that the probable measure of pricing differences across the two
markets is more than a cyclical lag effect.

Binomial options pricing tree in real options

Ho (2007) explores the pricing of real options for private real estate development.
He adopts a trinomial tree model by Hull and White, improvised from the binomial
option model. He discusses how an option in private real estate development is
analogous to a bond option with corresponding value factors. However, real options
only capture market risks, as they are dependent on the volatility of market risk, based
on the domestic common stock market.
Titman (1985) adopts a simple binomial model to explain why land lots remain
undeveloped, where the option is interpreted as an option to wait as an American call
without dividends. He concludes that the option to wait contributes significantly to the
value of land. Project related cash-flow gains, the uncertainty toward construction costs
and the risk-free interest rate positively influences the option value. Therefore, the
attractiveness of real estate development decreases. Williams (1991) supports Titman’s
results and further analyzes an option to abandon land, based on the value of project
developments. The option to abandon is interpreted as an American put without
dividends and an analytic model is adopted to solve the problem.
Despite the growing literature that covers option pricing for the financial options
and real options, there is virtually a dearth in the literature that adopts the binomial
option pricing tree model to examine the market efficiency of S-REITs. As the S-REITs
are listed on the Stock Exchange of Singapore (SGX) like common stocks but that the
S-REITS behave similarly to real estate to some extent (owing to its underlying real
estate asset illiquidity), there are similarities and differences from common stocks.
Owing to certain S-REIT risks inherent to its pricing, there is the need to examine
S-REIT pricing in-depth to protect investors from these risks. This paper takes a first
step by pricing the S-REIT via adopting the binomial options pricing tree model that is
JPIF consistent with the concept of risk neutral probabilities. Subsequent inferences and
34,5 findings can help to evaluate the market efficiency of S-REITs by comparing the
expected model price estimates with their historically observed prices.

REIT idiosyncratic risk

The binomial options pricing tree of S-REITs in this paper takes into account the volatility
500 (i.e. standard deviation) of selected and key S-REITs. Under modern portfolio theory
(MPT), the S-REIT investment risks consists of the market risk and the idiosyncratic risk.
The literature has been debating on whether or not REIT shares behave like typical
common stocks or like the underlying real estate assets that they own (Wang et al., 1995;
Ghosh et al., 1996; Chan et al., 2003). REIT behavior in relation to its market pricing and
idiosyncratic risks of the S-REIT returns should therefore enhance the understanding of
portfolio formation decisions and the hedging properties of REITs. The literature tends
instead to focus on either the degree of the REIT and the common stock market
integration or on the stability of REIT betas over time but with mixed results (Ling and
Naranjo, 1999; Glascock et al., 2000; Chiang et al., 2005; Fei et al., 2010; Liow and
Addae-Dapaah, 2010). DeLisle et al. (2013) reiterate that the extent of the potential
connections between REIT returns and the common stock market have not been
conclusive and that we do not know whether or not the S-REIT exposure to the aggregate
market volatility is duly priced in for a cross-sectional analysis of the S-REIT returns.
Idiosyncratic risk denotes firm specific risk and it is not captured by market risk
factors. It is argued that while idiosyncratic risk can be eliminated in a well-diversified
portfolio, most investors do not hold well-diversified portfolios owing to wealth
constraints or by choice. Institutional Investors need to care about the REIT’s
idiosyncratic risk (Xu and Malkiel, 2003) for several reasons. Some REITs resemble
small capitalization common stocks and REITs on the whole exhibit the same
investment style of the small value stocks (Chiang and Lee, 2002). REIT marginal
investors tend to be the individual or smaller institutional investors, who do not hold a
well-diversified portfolio (Pagliari et al., 2003). Thus, the idiosyncratic risk may be
priced in for some REITs. Arbitrageurs who trade to exploit REIT mispricing and
the institutional investors, who overweight the REIT sector to time the market, are
therefore exposed to the REITs’ idiosyncratic risk. When the REIT idiosyncratic risk is
high, then the REIT pricing errors may well be large (Ingersoll, 1987; Shleifer and
Vishny, 1997). Together with Ali et al. (2003), they argue that the idiosyncratic risk
deters arbitrage activities. Other studies allude to common stock portfolios that pose
higher idiosyncratic risk and that they record higher average TRs accordingly. Such
studies include those by Tinic and West (1986), Malkiel and Xu (1997, 2006),
Goyal and Santa-Clara (2003) and Fu (2005). These studies provide the empirical
support to Merton’s (1987) contention that in a world of incomplete information,
the under-diversified investors are compensated for not holding diversified portfolios.
Ooi et al. (2009) examine the role of idiosyncratic risk in the pricing of REIT stocks.
They reiterate that it is widely accepted that real estate assets and property-related
stocks have more exposure to idiosyncratic risk, owing to the inherently heterogeneous
and segmented nature of real estate. Capozza and Seguin (2003) find that REITs with
greater insider holdings tend to invest in assets with lower systematic risk. REIT
performance has been found to be closely linked to its underlying illiquid real estate
assets that are prone to booms and busts (Chaudhry et al., 2004).
Clayton and MacKinnon (2003) and Anderson et al. (2005) highlight that the growing
influence of the REIT idiosyncratic risk on TRs, and that this trend is consistent with
the REIT and fund managers’ attempt to outperform the market benchmark through REIT market
achieving higher investment alpha returns. Ooi et al. (2009) have even reported their efficiency
empirical results, which show that the US REIT sector’s variance of returns between
1990 and 2005 is significantly dominated by idiosyncratic risk. It is becoming clear that
idiosyncratic risk plays a significant role in the pricing of REIT stocks. These studies
are consistent with the argument by Merton (1987) and Malkiel and Xu (2006)
that idiosyncratic risk can be priced in an incomplete world, where investors hold 501
under-diversified portfolios either by choice or by constraints.
Chaudhry et al. (2004) state that the larger REITs are more likely to be
geographically diversified and they can therefore be more insulated from market price
fluctuations of the underlying direct real estate assets than the smaller REITs, which
are unable to achieve such a level of diversification. Thus, the larger REITs may well
have lower idiosyncratic risk. DeLisle et al. (2013) examine the pricing of volatility risk
in a cross-section study of equity REIT stock returns over the 1996-2010 period. They
find that in contrast to the negative and significant price of systematic volatility for
non-REIT equities, the systematic volatility is not priced into the REIT returns.
Idiosyncratic volatility from the Fama and French (1993) three-factor model, is
negatively priced in the cross-section and it is found to be largely independent of the
non-REIT idiosyncratic volatility. Within the total volatility profile, the idiosyncratic
volatility dominates aggregate volatility in REIT pricing. The implication is that REIT
managers should consider idiosyncratic risk when estimating the required return or the
cost of capital on individual common stocks or assets.
Chiang et al. (2009) have found that during the vintage REIT era, the REIT excess
return is positively related to idiosyncratic risk. However and in the new REIT era, the
REIT excess return is negatively related to idiosyncratic risk, where a lower REIT
idiosyncratic risk level is to be followed by a higher REIT return level and vice versa.
Their study suggests that the REIT idiosyncratic risk can be used to sharpen an
estimate of the expected REIT returns and to potentially time the REIT market. Miller
and Pandher (2008) examine the relation between idiosyncratic risk and the
cross-section of housing returns. They suggest that the positive relationship between
idiosyncratic risk and housing returns is owing to the lumpy nature of the housing
investment. Plazzi et al. (2008) also find that idiosyncratic volatility is duly priced in the
commercial real estate market, where such a unique risk is not diversified away
because commercial real estate is lumpy and illiquid. However, Gyourko and Nelling
(1996) have found that the common stock market data did not provide any evidence of
the REIT diversification across property types but that the broad geographic regions
actually resulted in a meaningful diversification.

REIT systematic risk

Systematic risk denotes the market risk and it cannot be mitigated through
diversification but only through hedging or through the right asset allocation strategy.
Gyourko and Nelling (1996) have found that REIT systematic risk seems to vary
according to the property type invested and with the associated beta being significantly
higher for the retail-oriented REIT, as compared to the REIT that owns industrial and
warehouse properties. Higher retail property returns in recent years is attributable to the
much higher return compensation for the underlying systematic risk. It should be noted
that both the REIT systematic risk and the idiosyncratic risk should enable investors to
better understand S-REIT pricing, and to serve as an effective explanation for the
potential occurrence of risk neutrality for this paper’s selected S-REITs.
JPIF Alpha is another risk measure of the active TR on an investment, compared to a
34,5 suitable market index. An alpha of 1.0 means the investment’s return on investment
over a selected period of time was 1 percent better than the market during that same
period. An alpha of −1.0 means the investment underperformed the market. Alpha is
one of the five key measures in MPT: alpha, beta, standard deviation, R2 and the Sharpe
ratio. The alpha coefficient (αi) is a parameter in the capital asset pricing model. It is the
502 intercept of the security characteristic line, that is, the coefficient of the constant in a
market model regression:


SCL: Ri;t
Rf ¼ ai þ bi Rm;t
Rf þ A i;t (1)

where Ri,t is the TR of investment i in time period t; Rf is the risk-free interest rate; αi is
the alpha risk; βi is the systematic market-wide risk; RM,t is the TR of the market; while
the last rem is the error term. In modern financial markets, where index funds are
widely available for purchase, alpha is deployed to assess the performance of mutual
funds and similar investments. As these funds include various fees, normally
expressed in percent terms, the funds have to maintain the alpha greater than its fees in
order to provide positive gains compared to an index fund.
Other risk measures in mathematical finance comprise the “Greeks”, i.e. the Greek
risks that denote the quantities, representing the sensitivity of the price of derivatives
like the options to a change in underlying parameters, on which the value of an
instrument or portfolio of financial instruments is dependent. Each Greek risk
measures the sensitivity of the value of a portfolio to a small change in a given
underlying parameter, so that component risks may be treated in isolation, and the
portfolio rebalanced accordingly to achieve a desired exposure. The most common of
the Greek risks are the first-order derivatives: Delta, Vega, Theta and Rho and Gamma,
a second-order derivative of the value function.
Delta. Of the first-order Greek risks, Delta, Δ, measures the rate of change of the
theoretical option value with respect to changes in the underlying asset’s price. Delta is
the first derivative of the value V of the option with respect to the underlying
instrument’s price:

@V
S: D ¼ (2)
@S

The (absolute value of) Delta is close to, but not identical with, the percent “moneyness”
of an option, i.e., the implied probability that the option will expire in-the-money (ITM),
if the market moves under Brownian motion in the risk-neutral measure. Thus, some
option traders use the absolute value of Delta as an approximation for percent
“moneyness”. For example and if an out-of-the-money (OTM) call option has a delta of
0.15, the trader may estimate that the option has about a 15 percent chance of expiring
ITM. If a put contract has a Δ of −0.25, the trader may expect the option to have a
25 percent probability of expiring ITM.
Vega. Vega measures sensitivity to volatility. Vega is the derivative of the option
value with respect to the volatility of the underlying asset:
@V
v¼ (3)
@s
Vega is typically expressed as the amount of money per underlying common stock that REIT market
the option’s value will gain or lose as volatility rises or falls by 1 percent. All options efficiency
(both calls and puts) will gain value with rising volatility. Vega can be an important
Greek risk to monitor in volatile markets because the value of some option strategies
can be particularly sensitive to changes in volatility.
Theta. Theta, Θ, measures the sensitivity of the value of the derivative to the
passage of time, the “time decay”: 503
@V
Y¼
(4)
@t

Theta is expressed in value per year. It is usual to divide the result by the number of
days in a year, to arrive at the amount of money per share of the underlying that the
option loses in one day. Theta is almost always negative for long calls and puts and
positive for short (or written) calls and puts. An exception is a deep ITM European put.
The total Theta for a portfolio of options can be determined by summing the Thetas for
each individual position. The option value can be analyzed into two parts: the intrinsic
value and the time value. The intrinsic value is the amount of money one will gain if one
exercised the option immediately. So a call with strike $50 on a stock with price $60 will
have the intrinsic value of $10, whereas the corresponding put will have zero intrinsic
value. The time value is the value of having the option of waiting longer before
deciding to exercise. Even a deeply out of the money put will be worth something, as
there is some chance the common stock price will fall below the strike price before the
expiry date. As time approaches maturity, there is less chance of this happening, so the
option time value is decreasing with time. Thus and if one is long an option then one is
short Theta, i.e. one’s portfolio will lose value with the passage of time, all other factors
held constant.
Rho. Rho, ρ, measures sensitivity to the interest rate. It is the derivative of the option
value with respect to the risk-free interest rate:

@V
r¼ (5)
@r

Except under extreme circumstances, the option value is less sensitive to changes
in the risk-free interest rate than to changes in other parameters. For this reason,
Rho is the least used of the first-order Greeks. Rho is typically expressed as the
amount of money per share of the underlying asset (common stock). The option value
will gain or lose as the risk-free interest rate rises or falls by 1.0 percent per annum
(100 basis points).
Lambda. Lambda, λ, or elasticity is the percentage change in option value per
percentage change in the underlying price:

@V S
l¼  (6)
@S V

Lambda is a Greek risk measure of leverage, sometimes known as gearing.

JPIF Gamma. Of the second-order Greek risks, Gamma, Γ, measures the rate of change in
34,5 the delta with respect to changes in the underlying price. Gamma is the second
derivative of the value function with respect to the underlying price:

@D @2 V
G¼ ¼ 2 (7)
@S @S
504
All long options have positive Gamma and all short options have negative Gamma.
Long options have a positive relationship with Gamma because as price increases, the
Gamma also increases upward, causing the Delta to approach 1 from 0 (long call option)
and 0 from −1 (long put option). The inverse is true for short options. Gamma is
greatest approximately at-the-money and diminishes the further out one goes either
ITM or OTM. Gamma is important because it corrects for the convexity of value. When
a trader seeks to establish an effective Δ-hedge for a portfolio, the trader may also seek
to neutralize the portfolio’s Gamma, as this will ensure that the hedge will be effective
over a wider range of underlying price movements.
On the whole, this paper evaluates whether or not the S-REIT will appeal to the risk
averse, risk taking or risk neutral investor. The S-REIT pricing is therefore examined
under its expected pricing measure (e) and its corresponding observed closing pricing
(o) measure. The paper adopts the decision tree of the binomial option pricing tree
model, which is based on the risk-neutral concept, to model the S-REIT expected
price estimates “e” in successive, forward, single step, multi periods. Primary data like
the historical prices of the selected S-REITs are collated and their e price series is
obtained. The root-mean-square (rms) of the series of the individual deviations of the
S-REIT “e” price from the S-REIT “o” price is imputed. The average of such a unique
series is compared with the standard deviation (SD) of the S-REIT “o” series.
If the (SD/Mean) ratio in percentage terms of the S-REIT “o” series is⩾rms of the
series of the individual deviations of the S-REIT “o” prices from the “e” prices, then the
deviation from the “e” risk neutral price is not significant, and that the S-REIT
is consistent with risk neutral pricing. If the rms of the series of the individual
deviations of the S-REIT “o” prices from the expected risk neutral price ratios in
percentage terms is greater, then the S-REIT is not consistent with risk neutral pricing.
Whether or not the investor is risk averse or risk taking, the average of the (o−e) values
is also imputed. If the average (o−e) value is negative, then the investor is deemed to be
risk averse because a larger proportion of the price curve falls below the risk neutral
line. If the average (o−e) value is positive, then the investor is deemed to be risk taking
because a larger proportion of the price curve falls above the risk-neutral line. Table I
lists the top ten largest REITs that are listed on the Stock Exchange of Singapore (SES).
These REITS are selected on the basis of their dominant market capitalization size and
they are obtained from the reliable and authoritative Bloomberg online information
and database system.
To enable a better run of the pricing model, five years of monthly historical prices
of the selected S-REITs are required. However, some of the selected S-REITs in the
list are merely listed for one to three years and these are eliminated owing to
insufficient data. The selected S-REIT list is eventually narrowed down to the top six
S-REITs, based on their dominant market capitalization. Available monthly data for
these top six S-REITs are collected and collated over a five-year time frame from
 Market capitalization
REIT market
No. REIT Type (S$ billions) efficiency
1 Capitamall Trust Shopping center 6.92
2 Ascendas REIT Diversified 5.35
3 Capitacommercial Diversified 4.24
4 Suntec REIT Diversified 3.61
5 Keppel REIT Office property 3.58 505
6 Mapletree Logistics Trust Diversified 2.68
7 Mapletree Greater China Commercial Trust Diversified 2.53 Table I.
8 Mapletree Commercial Trust Diversified 2.41 The top ten S-REITs
9 Mapletree Industrial Trust Warehouse/industrial 2.18 by market
10 Starhill Global REIT Shopping Center 1.81 capitalization as of
Sources: Bloomberg and Author (2014, 2016) July 11, 2013

January 2008 to December 2012. The time frame is long enough to facilitate meaningful
and in-depth analysis because the S-REIT market is relatively small and that it is still at
an emerging stage since year 2006, as observed in Figure 1.
The monthly interval is chosen for the pricing time series data instead of the daily
interval, owing to the latent smoothening of the S-REIT data that tends to lag the
financial market in time. As the S-REITs’ underlying portfolio are direct real estate
assets, it will take some time for a market correction to occur, owing to the valuation
processes (Geltner and Miller, 2001). Thus, S-REIT pricing should not only be
dependent on the domestic common stock market but also on the valuation of the
S-REITs’ underlying portfolio.

The binomial option pricing tree model

This paper adopts the single step form of the binomial option pricing tree model to estimate
the risk-neutral decision tree for each of the selected S-REITs. To understand how the
decision tree and the S-REIT pricing are estimated at each single step of a series of multi
periods, it is imperative to first understand the one-period binomial model of Figure 2.
At each step, it is assumed that with the initial price of S0 at period t ¼ 0, the price
will move up or down by a specific factor (u or d) in the next step (where u ⩾ 1 and
0 o d ⩽ 1). As depicted in Figure 2, the price in the next period will be either Su ¼ u × S0,
or Sd ¼ d × S0. The “u”and “d” variables are defined as follows:
pffiffiffiffiffiffi
u ¼ es Wt (8)
where σ is volatility of all monthly prices of a particular S-REIT over five years; Δt ¼
T/n ¼ 1/12 ¼ 0.083 as n ¼ 12 (i.e. the monthly prices), and:
pffiffiffiffiffiffi
1
d ¼ e
s Wt ¼ (9)
u
There are q and (1−q) values in Figure 2, where q represents the risk neutral probability
of the S-REIT price going up, and (1−q) represents the risk neutral probability of
the S-REIT price going down. The “q” and (1−q) variables are defined as follows:
ðR
dÞ
q¼ (10)
ðu
dÞ
JPIF ðu
RÞ
1
q ¼ (11)
34,5 ðu
dÞ

The multi-period binomial tree model can be estimated by treating each period as
individual one-period binomial models. Figure 3 depicts an example of the multi-period
binomial option tree model.
506 The binomial tree is a recombinant with the implication that if the underlying asset
moves up and then down (u,d), then the S-REIT price, St, will be the same as if it had
moved down and then up (d,u), i.e. where the two paths merge. To price an S-REIT at a
particular period, the risk neutral probabilities of an up-move, (q), and the risk-neutral
probability of a down-move, (1−q), are deployed to calculate St, with the help of the
following equation:
 
R
d u
R
Ct ¼ Cu þ Cd
u
d u
d
¼ ½qC u þ ð1
qÞC d 
¼ Εℚ
0 ½C t þ 1  (12)
The example of a three-period binomial model is depicted in Figure 4.
A step-by-step estimate of the price at period t ¼ 3 in Equation (13) can be outlined in
the following manner:
• From S0 to S31, it takes three up-moves [q, q, q] and hence the probability of S0 to
get to S31 is said to be q3.

S31
q
S21
q S32
S11 (1–q)
q q
S0 S22
(1–q)
q S33
S12 (1–q)
(1–q) q
S23
Figure 3. (1–q)
S34
The multi-period (1–q)
binomial option
t=0 t=1 t=2 t=3
model
Source: Authors (2016)

S31 q3
S21 q
q S32
S11 (1–q) 3q 2 (1–q)
S0 q S22 q
(1–q)
S12 q (1–q) S33
3q (1–q)2
(1–q) q
S23
Figure 4. (1–q)
S34 (1–q)3
A three-period (1–q)
binomial option t=0 t=1 t=2 t=3
pricing tree model
Source: Authors (2016)
 • From S0 to S32, there are three possible routes: The first route being an up-move, REIT market
up-move followed by a down-move [q, q, (1−q)]; second route being an up-move, efficiency
down-move and then an up-move [q, (1−q), q]; and the third route being a
down-move, up-move, and another up-move [(1−q), q, q]. Therefore, the
probability of S0 to get to S32 is 3q2(1−q).
• From S0 to S33, there are also three possible routes: The first route being an
up-move, down-move followed by a down-move [q, (1−q), (1−q)]; second route 507
being an down-move, up-move and then a down-move [(1−q), q, (1−q)]; and the
third route being a down-move, down-move and an up-move [(1−q), (1−q), q].
Therefore, the probability of S0 to get to S33 is 3q(1−q)2.
• From S0 to S34, it takes three down-moves [(1−q), (1−q), (1−q)] and hence the
probability of S0 to get to S34 is to be (1−q)3.
• To calculate the price S3 at period t ¼ 3, we multiply the respective probability
with the price:

S 3 ¼ q3 ðS 31 Þþ 3q2 ð1
qÞðS 32 Þþ 3qð1
qÞ2 ðS 33 Þ þ ð1
qÞ3 ðS 34 Þ (13)

For this paper, the following parameters of the model input are deployed:
Initial price: we take the initial price to be the adjusted closing price of each REIT at
period t ¼ 0, which in this case it will be the observed closing price o on January 2, 2008.
Time, Δt: Δt will be on calculated on a yearly basis and Δt ¼ 1/12 as prices are on a
monthly basis.
Volatility: volatility will be the variance of the adjusted closing prices for the whole
period of five years from January 2008 to December 2012.
Number of periods, n: as prices are on a monthly basis and for five years, n ¼ 60.
Risk-free rate, r: the risk-free rate, r is taken to be the prime-lending rate of
Singapore obtained from the Monetary Authority of Singapore (MAS). Throughout
January 2008 to December 2012, the annual risk-free rate is 5.38 percent.
Dividend yield: the dividend yield in this case will be 0 percent as this study
assumes that whatever dividend collected will be injected back as capital investment.
The risk-free interest rate parameter, r, is taken to be the prime-lending rate of
Singapore obtained from the MAS. From January 2008 to December 2012, the annual
risk-free rate is 5.38 percent. The dividend yield is taken to be 0 percent as this revised
paper envisages that whatever dividend collected will be injected back as capital
investment. The imputed risk-neutral probabilities are denoted by q and (1−q).

Comparing the binomial option tree model deviation of observations

After obtaining the estimated expected “e” prices of each period via the binomial option
pricing tree model, this paper compares them to the historically observed “o” prices,
obtained from the “Yahoo! Finance” website. From both the observed “o” and the
expected “e” prices, this paper derives the following two values in Equations (14) and (15):
(1) Average of (|(observed−expected)| divided by the corresponding o closing price)
(referred to as deviation/observed ratio from now on):
!
Xn
jot
et j
Cn  100% (14)
t¼1
ot
JPIF where ot represents the observed, et represents the expected, and n represents number
34,5 of periods, whereby n ¼ 60 for this study. This value tells us how much the deviation of
the observed o from the expected e prices is in proportion to the observed o price.
(2) Standard deviation of observed divided by the mean of observed (referred to as
standard deviation/mean ratio from now on):
Standard deviation of o
508  100% (15)
Mean of o
The two values show how much the observed standard deviation will be as a
proportion of its mean. The difference between the two values will be a vital result for
this paper and it will determine whether the S-REIT pricing is risk neutral or non-risk
neutral. Merely a readily and simple estimate is adequate for an indicative variance
estimate of the difference, comparing the variance for each S-REIT, based on the spread
of (e−o)/o and on the χ2 distribution, instead of the more precise binomial variance
measure of variance ¼ (nq(1−q)5).
Average of (o−e): the average of (o−e) values provides further analysis of the data to
determine whether or not the S-REIT pricing is risk taking or risk averse, i.e. non-risk
neutral. The associated expression is:
Pn
t¼1 ðot
et Þ
(16)
n
where ot represents the observed, et represents the expected and n represents number
of periods, whereby n ¼ 60 for this study.

Results and findings

The first stage of the analysis
The analysis for each S-REIT comprises two stages as depicted in Figure 5. In the first
stage of the analysis, this paper compares the (deviation/observed) ratio with the
(standard deviation/mean) ratio. The indicative difference between these two types of
ratios determines whether or not the S-REIT pricing is risk neutral or non-risk neutral.
In the second stage of the analysis, the paper looks at the average of the (o−e) values of
each S-REIT to determine whether or not the non-risk neutral S-REIT prices are risk

First Stage Second Stage

of Analysis of Analysis

Risk-neutral Risk-neutral

S-REIT

Risk-averse

Non-risk-neutral

Risk-taking
Figure 5.
The two-stage
analysis
Source: Authors (2016)
taking or risk averse, and to reinforce the paper’s findings on the risk neutrality of the REIT market
risk-neutral S-REITs. efficiency
The indicative difference between the (deviation/observed) ratio and the (standard
deviation/mean) ratio highlights the significance of the deviation of “o” from the model.
If the (standard deviation/mean) ratio is greater, then it means that the deviation of the
closing prices from the expected risk neutral model is not significant. We so conclude
that the S-REIT conforms to risk neutral pricing. If the (deviation/observed) 509
ratio is greater, then it means that the deviation of “o” from “e” is significantly large.
We so conclude that the S-REIT does not conform to risk neutral pricing. Table II
presents the results.
It is of interest that Capitacommercial Trust (CCT), Capitamall Trust (CMT) and
Keppel REIT are found to have indicatively large positive differences between the
(deviation/observed) ratio and the (standard deviation/mean) ratio (i.e. 39.86, 30.79 and
18.96 percent, respectively). It can be inferred that these three S-REITs are not trading
at risk neutral pricing. Suntec REIT has the indicatively positive difference of
2.35 percent, a relatively small and positive percentage difference. It may well be
trading at risk neutral pricing as the (deviation/observed) ratio is quite similar to the
(standard deviation/mean) ratio. Ascendas REIT has the largest negative difference
of −4.24 percent, to be followed by Mapletree Logistics Trust (MLT) at −0.44 percent.
It can be inferred that both these S-REITs are trading at risk neutral pricing.

The second stage of the analysis

The second stage of the analysis discusses each S-REIT’s “o” values and expected “e”
values, the volume bar chart and the average of the (o−e) values. The average of the
(o−e) values evaluates risk taking or risk averse pricing, should the S-REIT be found to
be non-risk neutral in the first stage of the analysis.
It affirms the likelihood of a risk neutral S-REIT. It is noteworthy that all the selected
S-REITs face a price dip in the period from August 2008 to April 2009. Such price dips
are experienced across the required sample data during this period, owing to the then
prevailing “Global Financial Crisis” (GFC). As the expected binomial option pricing tree
model does not fully incorporate this GFC factor, it is quite normal to anticipate that
the expected “e” price values can fall below the observed “o” price values during the
“August 2008 to April 2009” period.
CMT. From Figure 6, the CMT’s observed price value curve was relatively
optimistic in early 2008 but plunged thereafter, possibly owing to the then GFC, only to
reach its lowest price value in April 2009. The observed price value curve recovered
slightly but has been below the risk neutral line at around $1.60 per share.

Average of SD/mean Average

No. REIT [|(o−e)|/o] (%) of o (%) Difference (%) of (o−e)

1 Capitamall Trust 54.31 23.51 30.79 −0.780

2 Ascendas REIT 14.80 19.04 −4.24 −0.010
3 Capitacommercial Trust 67.30 27.44 39.86 −0.618
4 Suntec REIT 27.01 24.66 2.35 −0.139
5 Keppel REIT 41.32 22.35 18.96 −0.305 Table II.
6 Mapletree Logistics Trust 29.23 29.66 −0.44 −0.030 Results of the first
Source: Authors (2016) stage of the analysis
JPIF 3 20,000,000
18,000,000
34,5 2.5
16,000,000
14,000,000
2
12,000,000
1.5 10,000,000
8,000,000
510 1
6,000,000
4,000,000
0.5
2,000,000
0 0
1/1/2008
3/1/2008
5/1/2008
7/1/2008
9/1/2008
11/1/2008
1/1/2009
3/1/2009
5/1/2009
7/1/2009
9/1/2009
11/1/2009
1/1/2010
3/1/2010
5/1/2010
7/1/2010
9/1/2010
11/1/2010
1/1/2011
3/1/2011
5/1/2011
7/1/2011
9/1/2011
11/1/2011
1/1/2012
3/1/2012
5/1/2012
7/1/2012
9/1/2012
11/1/2012
Figure 6.
Price value curves
and the volume Volume traded Expected Observed
chart of CMT
Source: Authors (2016)

In January 2012, it began to rise steadily and approached $2.06 per share at December
2012. For the period from 2008 to 2012, CMT shares seemed to face risk
averse investors. A possible reason for the pricing inefficiency is the existence of
speculative activities attributable to CMT’s inherent idiosyncratic risk. As its assets
only comprise shopping centers, it is possible that there is insufficient diversification of
its underlying direct real estate asset portfolio despite attempts to diversify by owning
a stake in Capitaretail China Trust.
Figure 6 plots the two graphs of the expected e and observed o price values of CMT
and the volume of its shares traded over time. The expected price values follow a
straight upward sloping line while the actual closing price values follow a fluctuating
curve that goes above and then below the risk neutral line. It is found previously that
the observed CMT prices are not consistent with risk neutral pricing. For further
analysis, the distance between the observed price value curve above the line and that
distance between the observed price value curve below the line are considered. When
the observed price curve is above the line, the implication is that the S-REIT is being
traded by risk taking investors. When the observed price curve is below the line, the
implication is that the investors are risk averse.
The average of the (o−e) values is imputed to enable the conclusion as to whether
the investors are more risk averse or risk taking. If the average of the (o−e) value
is negative, it means that investors are mostly risk averse because a larger proportion
of the observed price value curve falls below the risk neutral line. If the average of the
(o−e) value is positive, it means that investors are risk taking because a larger
proportion of the observed price curve falls above the risk neutral line. For CMT, this
price value is imputed to be −0.780, from which it is inferred that the closing price
values have a risk averse tendency. Thus, the shares of CMT are subject to some
mispricing in which the market is relatively inefficient in pricing CMT’s shares.
The bar charts show the corresponding volume of share units that are being traded
over time. An observed and consistent trading volume implies that the CMT shares are
deemed to be relatively liquid.
The Ascendas REIT. Figure 7 shows the two graphs of the expected “e” and
the observed “o” prices for the Ascendas REIT while the bar chart portion shows the
corresponding volume of the Ascendas’ shares being traded, which are relatively
 2.5 12,000,000
REIT market
2 10,000,000 efficiency
8,000,000
1.5
6,000,000
1
4,000,000
0.5 2,000,000 511
0 0
1/1/2008
3/1/2008
5/1/2008
7/1/2008
9/1/2008
11/1/2008
1/1/2009
3/1/2009
5/1/2009
7/1/2009
9/1/2009
11/1/2009
1/1/2010
3/1/2010
5/1/2010
7/1/2010
9/1/2010
11/1/2010
1/1/2011
3/1/2011
5/1/2011
7/1/2011
9/1/2011
11/1/2011
1/1/2012
3/1/2012
5/1/2012
7/1/2012
9/1/2012
11/1/2012
Figure 7.
Price curves and
Volume traded Expected Observed
volume chart of
Ascendas REIT
Source: Authors (2016)

liquid. We have concluded previously that the Ascendas REIT is trading at risk neutral
pricing and with its mean value of (o−e) being −0.010, which is close to 0. Being risk
neutral means that the Ascendas REIT has efficient pricing for its shares and that there
may be only market risks and minimal idiosyncratic risks. As the Ascendas REIT’s
direct real estate portfolio mainly comprises industrial properties, portfolio
diversification may not readily explain its risk neutral pricing, owing to the low-risk
nature of industrial properties in Singapore, which results in low-idiosyncratic risk.
Nevertheless, the Ascendas REIT attempts commendable industrial portfolio
diversification into different types of industrial real estate assets at different
locations around Singapore, like the business and science parks, the high-specification
industrial factories, light industrial/flatted factories, the logistics and distribution
centers, warehouses and retail facilities.
Its REIT share prices plunged during the GFC period from August 2008 to March
2009 but slowly recovered after March 2009, and that its REIT share prices have
maintained relatively risk-neutral pricing from September 2009 to January 2012.
Pricing started to be speculative and increasingly risk taking after January 2012. More
time series and data need to be collected to establish whether or not its investors are
becoming increasingly risk taking in the future. From January 2008 to December 2012,
the Ascendas REIT pricing is consistent with risk neutral pricing, indicating strong
market efficiency.
The CCT. From Figure 8, the observed “o” price curve of CCT started slightly above
the expected risk neutral line at $1.80 per share on May 2008 but declined sharply to
reach its lowest price of $0.58 per share in March 2008; and that the observed price
curve has been performing below the risk neutral line ever since with slight optimism
in 2010-2011. However, the observed price curve dropped again in September 2011 and
made some recovery from November 2011, where the price seemed to be slowly
approaching the risk neutral line. CCT shares thus have varying liquidity, as evident
from the sharp spikes in volume and from some periods of very low volume.
CCT previously showed indicatively a relatively large positive difference of
39.86 percent between its (deviation/observed) ratio and its (standard deviation/mean)
ratio, which indicate non-risk neutral pricing. From its mean value of (o−e) of −0.618,
this negative value infers that the investors are risk averse to trading CCT shares,
resulting in weak market efficiency. The idiosyncratic risk of CCT’s underlying
JPIF 2
1.8
25,000,000

34,5 1.6 20,000,000

1.4
1.2 15,000,000
1
0.8 10,000,000

512 0.6
0.4 5,000,000
0.2
0 0
1/1/2008
3/1/2008
5/1/2008
7/1/2008
9/1/2008
11/1/2008
1/1/2009
3/1/2009
5/1/2009
7/1/2009
9/1/2009
11/1/2009
1/1/2010
3/1/2010
5/1/2010
7/1/2010
9/1/2010
11/1/2010
1/1/2011
3/1/2011
5/1/2011
7/1/2011
9/1/2011
11/1/2011
1/1/2012
3/1/2012
5/1/2012
7/1/2012
9/1/2012
11/1/2012
Figure 8.
Price curves and Volume traded Expected Observed
volume chart of CCT
Source: Authors (2016)

portfolio may be a possible reason that affects investor confidence. As most of CCT’s
direct real estate assets are commercial properties located in Singapore’s CBD, there
may well be less risk diversification of its portfolio. Another reason for the risk averse
pricing may well be that CCT owns a 40 percent interest in the building and
development of its CapitaGreen building. Such activity is deemed to be highly risky by
investors, as compared to an occupied building with a stable occupancy rate that
typical S-REITs should focus on. However, CCT has a diverse tenant mix for its
properties and its attempts at geographical diversification through a 30.0 percent stake
in Quill Capita Trust, a commercial REIT publicly listed in Malaysia, and a 7.4 percent
stake in the Malaysia Commercial Development Fund, a private investment fund for
real estate projects in Malaysia. Such diversification moves have not been envisaged to
be sufficient from the investors’ point of view. The result is risk averse pricing.
The Suntec REIT. The Suntec REIT pricing is more or less risk neutral with a very
small difference of 2.35 percent from its (deviation/observed) ratio to (standard
deviation/mean) ratio. From Figure 9, the observed price curve “o” is generally
comparable to the risk neutral line and that the dip from August 2008 to February 2009
can be owing to the GFC. This fall in prices during the GFC period should explain the

1.8 14,000,000
1.6 12,000,000
1.4
10,000,000
1.2
1 8,000,000
0.8 6,000,000
0.6
4,000,000
0.4
0.2 2,000,000

0 0
1/1/2008
3/1/2008
5/1/2008
7/1/2008
9/1/2008
11/1/2008
1/1/2009
3/1/2009
5/1/2009
7/1/2009
9/1/2009
11/1/2009
1/1/2010
3/1/2010
5/1/2010
7/1/2010
9/1/2010
11/1/2010
1/1/2011
3/1/2011
5/1/2011
7/1/2011
9/1/2011
11/1/2011
1/1/2012
3/1/2012
5/1/2012
7/1/2012
9/1/2012
11/1/2012

Figure 9.
Price curves and
volume chart of Volume traded Expected Observed
Suntec REIT
Source: Authors (2016)
slightly negative mean of the (o−e) value of −0.139. It is implicit that the Suntec REIT REIT market
pricing is relatively risk neutral with strong market efficiency. efficiency
The Suntec REIT underlying direct real estate portfolio is as diversified as that of CCT
but that the Suntec REIT’s commercial real estate assets are being more confined to the
CBD areas, inclusive of the Marina Bay area, as opposed to being evenly spread out and
across Singapore island-wide. The Suntec REIT diversification is relatively more
concentrated and may compel risk neutral investors to trade the Suntec REIT shares. 513
The Keppel REIT. From the first stage of the analysis, Keppel REIT is found to be
not risk neutral with a 18.96 percent difference between its (deviation/observed) ratio
and its (standard deviation/mean) ratio. Its observed price curve “o”, depicted
in Figure 10, is mostly under the risk neutral price curve; and together with an average
(o−e) value of −0.305, the implication is that Keppel REIT’s investors are slightly risk
averse, implying semi-strong market efficiency. The price curve experienced a dip
during the then GFC period and a slight recovery in November 2010 when it hovered
near the risk neutral line. However, the observed price curve dipped again from July
2011 to November 2011, where it rose and sloped toward the risk neutral line thereafter.
The Keppel REIT underlying direct real estate portfolio consists of only Grade-A
office assets and that the Keppel REIT is not sectorally diversified, but that its
underlying portfolio is geographically diversified through its holding of premium office
real estate in Australia. Investors may well be slightly risk averse toward the Keppel
REIT portfolio, owing to its highly specialized sector of premium office space.
The MLT. MLT’s pricing is inferred to be risk neutral from the first stage of the
analysis and from a −0.44 percent difference of its (deviation/observed) ratio from its
(standard deviation/mean) ratio. Its average (o−e) value of −0.030 is relatively small.
From Figure 11 and besides the price dip during the period of GFC, the observed price
curve “o” recovered to hover near or along the risk neutral line from early 2010 to
December 2011. Since January 2012, the observed price curve has been rising to be
above the risk neutral line. Throughout the sample period from years 2008 to 2012, the
MLT is deemed to be traded by relatively risk neutral investors.
The MLT holds industrial real estate assets in many major cities of Asia, namely,
Singapore, Malaysia, China, Hong Kong, Japan, South Korea and Vietnam. This shows
that MLT’s underlying direct real estate portfolio is well-diversified by city and by
country. It is possible that the MLT has a much reduced or negligible idiosyncratic risk

1.4 2,500,000

1.2
2,000,000
1

0.8 1,500,000

0.6 1,000,000
0.4
5,00,000
0.2

0 0
1/1/2008
3/1/2008
5/1/2008
7/1/2008
9/1/2008
11/1/2008
1/1/2009
3/1/2009
5/1/2009
7/1/2009
9/1/2009
11/1/2009
1/1/2010
3/1/2010
5/1/2010
7/1/2010
9/1/2010
11/1/2010
1/1/2011
3/1/2011
5/1/2011
7/1/2011
9/1/2011
11/1/2011
1/1/2012
3/1/2012
5/1/2012
7/1/2012
9/1/2012
11/1/2012

Figure 10.
Price curves and
Volume traded Expected Observed
volume chart of
Keppel REIT
Source: Authors (2016)
JPIF 1.2 14,000,000

34,5 1 12,000,000

10,000,000
0.8
8,000,000
0.6
6,000,000
0.4
514 4,000,000
0.2 2,000,000

0 0

11/1/2012
1/1/2008
3/1/2008
5/1/2008
7/1/2008
9/1/2008
11/1/2008
1/1/2009
3/1/2009
5/1/2009
7/1/2009
9/1/2009
11/1/2009
1/1/2010
3/1/2010
5/1/2010
7/1/2010
9/1/2010
11/1/2010
1/1/2011
3/1/2011
5/1/2011
7/1/2011
9/1/2011
11/1/2011
1/1/2012
3/1/2012
5/1/2012
7/1/2012
9/1/2012
Figure 11.
Price curves
and volume Volume traded Expected Observed
chart of MLT
Source: Authors (2016)

for its assets that is consistent with prudential asset allocation for viable real estate
portfolio investing. Another possible reason may well be that the industrial S-REITs
are generally perceived to be holding direct real estate assets with lower idiosyncratic
risk, as compared to the commercial S-REITs (Gyourko and Nelling, 1996). From the
foregoing results and findings, it is explicit that half of the S-REITs in the sampled data
exhibits risk neutral pricing while the other half exhibits risk averse pricing. Common
stock prices of CMT, CCT and the Keppel REIT show on the whole a risk averse
tendency while the Ascendas REIT, the Suntec REIT and the MLT show the risk
neutral tendency.
The group of S-REITs that exhibit risk neutral pricing suggests strong market
efficiency for their own REIT share prices and that this is attributable to their exposure
to lower risks, through sufficient diversification of their underlying direct real estate
portfolios. It may well be that investors perceive the industrial REITs to be generally
less risky, and therefore the direct real estate asset type may be one key factor that
contributes to lower market risk. Industrial REITs seem to have relatively risk neutral
pricing, as compared to commercial REITs. It is noteworthy that none of the selected
S-REITs show compelling risk-taking behavior from investors, pointing instead to the
risk neutral and the risk averse S-REIT pricing.
This paper generally affirms the binomial options pricing tree model to be consistent
with prudential asset allocation for viable S-REIT portfolio investing. However, the
S-REIT pricing can be relatively unpredictable and that not all S-REITs show strong
market efficiency in their pricing. The S-REIT may be risk neutral over a certain period
but that investor or market sentiments, the fear of risks and the occurrence of
speculative activities can still adversely affect the S-REIT’s risk neutrality.
Nevertheless, with enhanced and more than sufficient risk diversification activities,
it is possible for an S-REIT to achieve risk neutral pricing. It boils down to the amount
of its risk exposure and how much confidence that investors have in an S-REIT’s
portfolio and its returns.

Conclusion
In summary, this paper examines the market efficiency of S-REITs through S-REIT
pricing to enable investors to better understand the inherent risks of the S-REITs, and
to facilitate more effectively viable investment decisions and S-REIT portfolio
diversification. This paper examines the S-REIT pricing of the top six S-REITs ranked REIT market
by their dominant market capitalization from January 2008 to December 2012. For each efficiency
S-REIT, the expected “e” pricing, which is consistent with the risk neutral concept, is
modeled from the binomial option pricing tree, and is then compared with the
corresponding deviation from the observed closing “o” pricing. The paper conducts a
two-stage analysis. For the first stage of the analysis, the rms of the series of the
indicative individual deviations of the S-REIT “e” price from the S-REIT “o” price are 515
readily estimated, and then evaluated to conclude whether or not the S-REITs exhibit
risk neutrality. If the (standard deviation/mean) ratio in percentage terms of the S-REIT
“o” series⩾the rms of the series of the individual deviations of the S-REIT “o” prices
from “e” prices, then the deviation from the “e” risk neutral price is not significant and
that the S-REIT is consistent with risk neutral pricing. If the rms of the series of
individual deviations of the S-REIT “o” prices from “e” ratios in percentage terms is
greater, then the S-REIT is not consistent with risk neutral pricing.
For the second stage of the analysis, the average of the (o−e) values is estimated to
conclude whether or not investors are more risk averse or risk taking. If the value is
negative (positive), it means that investors are mostly risk averse (risk taking). The
results and findings show that half of the S-REITs in the sampled data exhibits risk
neutral pricing, and that the other half exhibits risk averse pricing. The CMT, CCT and
Keppel REIT show risk averse pricing, while the Ascendas REIT, Suntec REIT and
MLT show risk neutral pricing.
The S-REITs that exhibit risk neutral pricing suggests strong market efficiency for
their own REIT common stock and that this is attributable to their exposure to the
lower idiosyncratic risk through sufficient diversification of their underlying direct real
estate portfolios. Another possible reason may well be that investors perceive the
industrial REITs to be generally less risky, and therefore the direct real estate asset
type may be one key factor that contributes to lower total risk. From the results, the
industrial REITs seem to have a relatively risk neutral pricing, as compared to
commercial REITs. It is worth noting that none of the selected S-REITs show
compelling risk taking behavior from investors, pointing to only risk neutral and risk
averse S-REIT pricing.
The binomial options pricing tree model is consistent with prudential asset
allocation for viable S-REIT portfolio investing. However, the S-REIT pricing can be
relatively unpredictable and that not all S-REITs have strong market efficiency in their
pricing. The S-REIT may be risk neutral over a certain period but that investor or
market sentiments, the fear of risks and the occurrence of speculative activities can still
adversely affect the S-REIT’s risk neutrality. However, with enhanced and more than
sufficient portfolio risk diversification activities, it is possible for an S-REIT to achieve
risk neutral pricing. It boils down to the amount of its risk exposure and how much
confidence that investors have in the S-REIT’s portfolio and its returns.

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Appendix. Explanation of binomial asset tree price model workings in excel files

S31 q3
S21 q

S11 q S32
(1–q)
3q 2 (1–q)
q q
S0 (1–q) S22
S12 q (1–q) S33
(1–q) 3q (1–q)2
q
S23
(1–q) Figure A1.
S34
(1–q) (1–q)3 A binomial asset tree
t=0 t=1 t=2 t=3
price (Constant
Mesh) Model
Source: Authors (2016)
JPIF
34,5

Calculating the risk-neutral probabilities q and (1−q)

For the 1st term:
518 Coefficient ¼ 1, power of q ¼ 3, power of (1−q) ¼ 0
For the 2nd term:
Coefficient ¼ 3, power of q ¼ 2, power of (1−q) ¼ 1
For the 3rd term:
Coefficient ¼ 3, power of q ¼ 1, power of (1−q) ¼ 2
For the 4th term:
Coefficient ¼ 1, power of q ¼ 0, power of (1−q) ¼ 3
Hence, our excel working would be:
Power of q ¼ corresponding row number
Power of (1−q) ¼ column number (period)−row number
Coefficient: combination (column number, row number) ¼ column number choose row number
As shown in Figure A2, for Cell C142, the required formula is ¼ IF($A75 o ¼ C$15,COMBIN
(C$15,C$15-$A75) *$B$10^$A75*$B$11^(C$15-$A75)," ")
Where COMBIN(C$15,C$15-$A75) ¼ 1st term’s coefficient, multiplied by q (cell B10) to the
power of corresponding row number (cell A75), multiplied by (1−q) (cell B11) to the power of the
column number (period)−row number (cell C15-cell A75)
Lastly the expected price will be the sum product of the coefficients and the risk neutral
probabilities, where the
Sum Product ¼ Sum of [coefficients×all q terms×all (1−q) terms×price].
(1) The REIT parameters in Figure A3 are the input parameters for the Binomial model. The
risk-free interest rate, r, is taken to be the prime-lending rate of Singapore obtained from
the Monetary Authority of Singapore (MAS). Throughout January 2008 to December
2012, the annual risk-free rate is 5.38 percent. The dividend yield is taken to be
0 percent as the study envisages that whatever dividend collected will be injected back as
capital investment.
(2) Figure A4 shows the corresponding Binomial Tree Model for the u and d prices at each
period for CMT. For the example of cell C75, the formula input is ¼ IF($A75 o C$15,$B
$9*OFFSET(C75,0,-1), IF($A75 ¼ C$15,$B$8*OFFSET(C75,1,-1),"")).

Figure A2.
Formula for
calculating
expected price
Source: Authors (2016)
Where A75 is the row number and C15 is the column number. As it is a binomial tree, we REIT market
only want Figure A5 to appear when the row number is smaller or equal to the column number.
The offset function is a type of referencing function.
efficiency
For example, OFFSET(C75,1,−1):
• C75 – the referenced cell.
• 1 – indicates the number of rows to move. Positive numbers mean move down, and
negative numbers mean move up. 0 means the same row. 519
• −1 – indicates the number of columns to move. Positive numbers mean move to the right,
and negative numbers mean move to the left.
The OFFSET function returns the value of the cell that is located in the 1 row below (1) and 1 row
to the left (−1) of cell C75 (which is cell B76). The value in cell B76 is "2.39". Therefore, the formula
returns "2.39". And so we will multiply 2.39 with u as it is an upward movement.
If the row number is smaller than the column number, it is a downward movement. If the row
number is equal to the column number, it will be an upward movement. In this case, C75 is
column number 1, row number 1, hence it will be an upward movement from cell B76 (u×B76).
Next, we have to calculate the expected price at each period based on the binomial tree we have
obtained. From our Binomial working, we use the following example (Figure A3) to calculate the
price S3 at period t ¼ 3, where we multiply the respective probability with the price.

Figure A3.
Sum product formula
Source: Authors (2016)

Figure A4.
Input parameters for
binomial model
Source: Authors (2016)
JPIF
34,5

520

Figure A5.
Binomial tree
for CMT
Source: Authors (2016)

Corresponding author
Kim Hin David Ho can be contacted at: rsthkhd@nus.edu.sg

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