Using Option Market Liquidity to Predict REIT Leverage Changes

Recent literature has shown that liquidity is important in explaining price effects for firms and firm decisions. For example, see Morellec (Journal of Financial Economics, 61(2), 173-206, 2001) and Bharath et al. (Review of Financial Studies, 22(8), 3211-3243, 2009). We follow and extend that literature by looking at the liquidity of market based options to forecast REIT capital structure changes. REITs, unlike typical listed firms, tend to have high leverage and a more dynamic capital structure because of regulation. Thus, understanding potential management behavior could be important to investors. By looking at actions of the managers as revealed through the liquidity in the option's market, we are able to estimate what REIT managers are likely to do in terms of future capital structure changes. We do so using option data which update at higher frequency than traditional accounting characteristics. Our results are similar to those of Borochin and Yang (2016) who study this issue for non-REIT firms. We find that REITs with higher historical volatility or lower option market liquidity (as measured by number of daily unique call options, daily call open interest, and daily volume of option traded) are less likely to increase leverage in the following quarter. REITs with higher option liquidity or lower realized volatility are more likely to increase net long-term debt (issuing more debt or retire less debt) in the following quarter.