REITs are stocks that have underlying real estate assets, priced in the financial market, whose returns behave like direct properties in the long term (Hoesli & Oikarinen, 2012). However, the linkage of returns between listed real estate market, such as REITs, and the stock market varies in different countries. Particularly, Hoesli and Oikarinen (2012) find no tight links of returns in the Australian market. Previous studies mainly focus on the return volatilities in the US markets (Clayton & MacKinnon, 2003; Yang et al., 2012), while it is unclear what the return volatility and spillover effects are between the listed real estate market and the stock market in Australia, and how the pricing factors of REITs reflect the change of such linkages. The key research question is, how does this linkage change in different regimes (market states) of the two markets? By integrating the behavioural finance theory, this research add knowledge to the interpretation of the volatilities of returns transmission between the Australian real estate securities market and the capital market in peaks and Troughs.

This paper aims to improve the explanatory power of the traditional asset pricing model by quantifying and incorporating the human elements, thereby providing another perspective for real estate fund managers to generate appropriate investment strategies. This study is designed to assess the hypothesis that REIT and stock markets share certain periods of crisis regimes and have different stable regimes respectively. To investigate different regimes of REITs and stocks, it is essential to first identify the return sensitivity and volatility of REIT and stock with CAPM (Capital Asset Pricing Model) and ARCH (Autoregressive Conditional Heteroskedasticity) model. Together with the analysis of spillover effects, the regime switch study provides an overall picture of how market state will change given current market condition. The modification to the CAPM model considering the behavioural factors and market anomalies presents a new direction for listed real estate research.

Arbitrage is another key factor in asset pricing, but the real estate market is subject to limits to arbitrage. Fundamental risk, implementation costs, and discrepancies persist in the securities market when arbitrage opportunities seem profitable but the risks arise from illiquidity and volatility pose limits to arbitrage (Shleifer & Vishny, 1997). Globally, REITs have grown at around 17 per cent from 2007 to 2014, primarily driven by equity REITs (McKinsey 2015). Australia has the second-largest REITs market in Asia and is considered a near mature market with a ten-year average yield of 5.2% (Savills 2019).