Contagion Channels between Real Estate and Financial Markets∗

The recent crisis has demonstrated the close linkages between various asset classes within a country as well as the association between assets internationally. The aim of this research is to provide for a better understanding of some of these linkages by conducting an empirical investigation of the channels underlying the risk of contagion between real estate and financial markets in the United States. We test for three financial mechanisms driving contagion: Information correlation, liquidity correlation, and portfolio rebalancing. A behavioral dimension in the crisis propagation is also examined by considering investor sentiment and panic risk in our analyses. A methodology based on quantile regressions and copulas is utilized for carrying out those tests. We find that contagion prevails between real estate and financial markets and that this is driven by behavioral and liquidity mechanisms. The correlated information and portfolio rebalancing hypotheses are strongly rejected. The results of this research should prove useful to investors seeking to hedge against market crashes as well as to policy makers who aim to mitigate such stressful episodes. JEL Classification: G01; G12; G02; G14