Volatility Spillovers and Regional Office Market Connectedness in the UK

Abstract

Economic integration and regional connectedness within countries may imply limited opportunities for investment portfolio diversification. Previous research on UK office markets has identified similarities between regions in relation the sensitivity of rent to demand and supply side factors (Hendershott et al., 2002). Furthermore, Attanasio et al., (2009) note that there may be some form of common causality that links regions therefore leading to significant correlations. However, regions vary in value added and as indicated by Stevenson et al., (2014), the performance of real estate assets is driven by economic fundamentals more so than in the case of capital markets. While international investment may deliver portfolio diversification, the fact that real estate investment is highly concentrated in a small number of key cities whose economies are often underpinned by the financial sector, may result in renewed interest in, and a re-examination of, investment opportunities in regions within a given country.Therefore, in this paper we examine office markets in the six main regional cities in the UK, after London. First, we provide evidence of the extent to which regional real estate markets and economies are correlated. Second, we adopt a generalised vector autoregressive approach to capture return and volatility spillovers. Third, following the research developed by Diebold and Yilmaz (2009) we employ variance decomposition analysis to find the share of each city’s own variance to itself and to other cities. Finally, we whether relationships are stable or time varying and therefore the extent to which diversification benefits may still exist.