Currency And Property Markets: Analysing The Correspondence in a Floating Exchange Rate Environment

This paper compares the effects of exchange rate movements on the risk/return characteristics of direct investment property assets for non-domestic investors with particular emphasis on economic and translation risk. The correspondence between four property markets (US, UK, Canada, and Australia) and the appropriate exchange rates are examined in order to analyse the pattern and temporal stability of the interrelationships. The findings suggest that, on an individual foreign property investment basis, exchange rate movements exaberate risk without any compensating increase in return. Nevertheless, the effect of exchange rate movements is to reduce correlations between property markets and thus increase diversification possibilities. Introduction Exchange rate risk is an additional source of risk to investing outside the domestic asset markets. For the international property investor variations in exchange rates can affect the investment performance of a property asset separate from the underlying performance of the asset. Previous analysis of international property investment and exchange rate risk has explicitly recognised the potential of adverse movements in the currency markets to alter the expected risk and return characteristics of the investment (see Ziobrowski and Ziobrowski, 1995, Ziobrowski et al, 1997, Worzala, 1995; Worzala, Johnson and Lizieri, 1996; Newell and Worzala, 1995, Dawson and Rodney, 1994). However, although the focus of much of this research has been on methods to mitigate or eliminate currency risk, the empirical findings suggest that investors in nondomestic direct property tend not to use hedging techniques. This may be attributed to the costs of hedging and the problems associated with identifying an optimal hedging strategy. In addition, given the lack of research on the impact of currency fluctuations on patterns of property return and risk, empirical investigation is required. Thus, this paper analyses the effects of exchange rate movements on the risk/return characteristics of direct investment property assets for non-domestic investors with particular emphasis on economic and translation risk. The core issue to be examined is whether exchange rate movements tend to exacerbate or mitigate the effects of direct property market volatility for the non-domestic investor in a floating exchange rate environment. With globalisation and internationalisation, there have been significant increases in international trade and investment. International portfolio diversification is now wellestablished amongst investing institutions. Financial market integration, deregulation and advances in telematics have led to increased capital mobility and expanded the investment opportunities available to investing institutions. In comparative terms, British investing institutions seem to have been particularly positive about the opportunities of international portfolio diversification with non-domestic investments steadily increasing their relative importance in the typical portfolio. The share of British pension fund assets held in foreign securities rose from 10% in 1980 to 20% in 1993. The comparative figures for American and Japanese pension funds are from