IDEAS home Printed from https://ideas.repec.org/a/bla/reesec/v37y2009i3p341-381.html
   My bibliography  Save this article

Time and Risk Diversification in Real Estate Investments: Assessing the Ex Post Economic Value

Author

Listed:
  • Carolina Fugazza
  • Massimo Guidolin
  • Giovanna Nicodano

Abstract

Welfare gains to long‐horizon investors may derive from time diversification that exploits nonzero intertemporal return correlations associated with predictable returns. Real estate may thus become more desirable if its returns are negatively serially correlated. While it could be important for long‐horizon investors, time diversification has been mostly investigated in asset menus without real estate and focusing on in‐sample experiments. This article evaluates, ex post, the out‐of‐sample gains from diversification when equity real estate investment trusts (REITs) belong to the investment opportunity set. We find that diversification into REITs increases both the Sharpe ratio and the certainty equivalent of wealth for all investment horizons and for both classical and Bayesian (who account for parameter uncertainty) investors. The increases in Sharpe ratios are often statistically significant. However, the out‐of‐sample average Sharpe ratio and realized expected utility of long‐horizon portfolios are frequently lower than that of a one‐period portfolio, which casts doubt on the value of time diversification.

Suggested Citation

  • Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2009. "Time and Risk Diversification in Real Estate Investments: Assessing the Ex Post Economic Value," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 37(3), pages 341-381, September.
    • Handle: RePEc:bla:reesec:v:37:y:2009:i:3:p:341-381
    DOI: 10.1111/j.1540-6229.2009.00245.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1540-6229.2009.00245.x
    Download Restriction: no
    File URL: https://libkey.io/10.1111/j.1540-6229.2009.00245.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Martin Lettau & Stijn Van Nieuwerburgh, 2008. "Reconciling the Return Predictability Evidence," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1607-1652, July.
    2. Ivo Welch & Amit Goyal, 2008. "A Comprehensive Look at The Empirical Performance of Equity Premium Prediction," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1455-1508, July.
    3. John Y. Campbell & Yeung Lewis Chanb & M. Viceira, 2013. "A multivariate model of strategic asset allocation," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part II, chapter 39, pages 809-848, World Scientific Publishing Co. Pte. Ltd..
    4. Puneet Handa, 2006. "Does Stock Return Predictability Imply Improved Asset Allocation and Performance? Evidence from the U.S. Stock Market (1954–2002)," The Journal of Business, University of Chicago Press, vol. 79(5), pages 2423-2468, September.
    5. Avramov, Doron & Chordia, Tarun, 2006. "Predicting stock returns," Journal of Financial Economics, Elsevier, vol. 82(2), pages 387-415, November.
    6. Kandel, Shmuel & Stambaugh, Robert F, 1996. "On the Predictability of Stock Returns: An Asset-Allocation Perspective," Journal of Finance, American Finance Association, vol. 51(2), pages 385-424, June.
    7. John Y. Campbell & Robert J. Shiller, 1988. "Stock Prices, Earnings and Expected Dividends," Cowles Foundation Discussion Papers 858, Cowles Foundation for Research in Economics, Yale University.
    8. David M. Geltner, 1993. "Estimating Market Values from Appraised Values without Assuming an Efficient Market," Journal of Real Estate Research, American Real Estate Society, vol. 8(3), pages 325-346.
    9. Ling, David C & Naranjo, Andy & Ryngaert, Michael D, 2000. "The Predictability of Equity REIT Returns: Time Variation and Economic Significance," The Journal of Real Estate Finance and Economics, Springer, vol. 20(2), pages 117-136, March.
    10. John G. Gallo & Larry J. Lockwood & Mauricio Rodriguez, 2006. "Differentiating CREF Performance," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 34(2), pages 173-209, June.
    11. John Y. Campbell & Luis M. Viceira, 2005. "The Term Structure of the Risk–Return Trade-Off," Financial Analysts Journal, Taylor & Francis Journals, vol. 61(1), pages 34-44, January.
    12. Wachter, Jessica A. & Warusawitharana, Missaka, 2009. "Predictable returns and asset allocation: Should a skeptical investor time the market?," Journal of Econometrics, Elsevier, vol. 148(2), pages 162-178, February.
    13. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2007. "Investing for the Long-run in European Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 34(1), pages 35-80, January.
    14. Massimo Guidolin & Allan Timmermann, 2005. "Economic Implications of Bull and Bear Regimes in UK Stock and Bond Returns," Economic Journal, Royal Economic Society, vol. 115(500), pages 111-143, January.
    15. repec:bla:jfinan:v:43:y:1988:i:3:p:661-76 is not listed on IDEAS
    16. Liu, Crocker H & Mei, Jianping, 1992. "The Predictability of Returns on Equity REITs and Their Co-movement with Other Assets," The Journal of Real Estate Finance and Economics, Springer, vol. 5(4), pages 401-418, December.
    17. LuisM. Viceira & John Y. Campbell, 2001. "Who Should Buy Long-Term Bonds?," American Economic Review, American Economic Association, vol. 91(1), pages 99-127, March.
    18. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December.
    19. Paul A. Samuelson, 2011. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," World Scientific Book Chapters, in: Leonard C MacLean & Edward O Thorp & William T Ziemba (ed.), THE KELLY CAPITAL GROWTH INVESTMENT CRITERION THEORY and PRACTICE, chapter 31, pages 465-472, World Scientific Publishing Co. Pte. Ltd..
    20. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
    21. Avramov, Doron, 2002. "Stock return predictability and model uncertainty," Journal of Financial Economics, Elsevier, vol. 64(3), pages 423-458, June.
    22. Jobson, J D & Korkie, Bob M, 1981. "Performance Hypothesis Testing with the Sharpe and Treynor Measures," Journal of Finance, American Finance Association, vol. 36(4), pages 889-908, September.
    23. Geltner, David & Mei, Jianping, 1995. "The Present Value Model with Time-Varying Discount Rates: Implications for Commercial Property Valuation and Investment Decisions," The Journal of Real Estate Finance and Economics, Springer, vol. 11(2), pages 119-135, September.
    24. Rakesh Bharati & Manoj Gupta, 1992. "Asset Allocation and Predictability of Real Estate Returns," Journal of Real Estate Research, American Real Estate Society, vol. 7(4), pages 469-484.
    25. Fishburn, Peter C, 1977. "Mean-Risk Analysis with Risk Associated with Below-Target Returns," American Economic Review, American Economic Association, vol. 67(2), pages 116-126, March.
    26. Karolyi, G Andrew & Sanders, Anthony B, 1998. "The Variation of Economic Risk Premiums in Real Estate Returns," The Journal of Real Estate Finance and Economics, Springer, vol. 17(3), pages 245-262, November.
    27. Michael W. Brandt, 1999. "Estimating Portfolio and Consumption Choice: A Conditional Euler Equations Approach," Journal of Finance, American Finance Association, vol. 54(5), pages 1609-1645, October.
    28. William Goetzmann & Jonathan Ingersoll & Matthew I. Spiegel & Ivo Welch, 2002. "Sharpening Sharpe Ratios," NBER Working Papers 9116, National Bureau of Economic Research, Inc.
    29. Bossaerts, Peter & Hillion, Pierre, 1999. "Implementing Statistical Criteria to Select Return Forecasting Models: What Do We Learn?," The Review of Financial Studies, Society for Financial Studies, vol. 12(2), pages 405-428.
    30. Chakradhara Panda & V. Narasimhan, 2006. "Predicting Stock Returns," South Asia Economic Journal, Institute of Policy Studies of Sri Lanka, vol. 7(2), pages 205-218, September.
    31. Michael Cooper & Roberto C. Gutierrez, Jr. & Bill Marcum, 2005. "On the Predictability of Stock Returns in Real Time," The Journal of Business, University of Chicago Press, vol. 78(2), pages 469-500, March.
    32. John Y. Campbell & Luis M. Viceira, 1999. "Consumption and Portfolio Decisions when Expected Returns are Time Varying," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(2), pages 433-495.
    33. Jorion, Philippe, 1985. "International Portfolio Diversification with Estimation Risk," The Journal of Business, University of Chicago Press, vol. 58(3), pages 259-278, July.
    34. Fisher, Jeffrey D & Geltner, David M & Webb, R Brian, 1994. "Value Indices of Commercial Real Estate: A Comparison of Index Construction Methods," The Journal of Real Estate Finance and Economics, Springer, vol. 9(2), pages 137-164, September.
    35. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
    36. Pesaran, M Hashem & Timmermann, Allan, 1995. "Predictability of Stock Returns: Robustness and Economic Significance," Journal of Finance, American Finance Association, vol. 50(4), pages 1201-1228, September.
    37. Glascock, John L & Lu, Chiuling & So, Raymond W, 2000. "Further Evidence on the Integration of REIT, Bond, and Stock Returns," The Journal of Real Estate Finance and Economics, Springer, vol. 20(2), pages 177-194, March.
    38. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-257, August.
    39. Hoevenaars, Roy P.M.M. & Molenaar, Roderick D.J. & Schotman, Peter C. & Steenkamp, Tom B.M., 2008. "Strategic asset allocation with liabilities: Beyond stocks and bonds," Journal of Economic Dynamics and Control, Elsevier, vol. 32(9), pages 2939-2970, September.
    40. Mei, Jianping & Liu, Crocker H, 1994. "The Predictability of Real Estate Returns and Market Timing," The Journal of Real Estate Finance and Economics, Springer, vol. 8(2), pages 115-135, March.
    41. Cho, Hoon & Kawaguchi, Yuichiro & Shilling, James D, 2003. "Unsmoothing Commercial Property Returns: A Revision to Fisher-Geltner-Webb's Unsmoothing Methodology," The Journal of Real Estate Finance and Economics, Springer, vol. 27(3), pages 393-405, November.
    42. Nicholas Barberis, 2000. "Investing for the Long Run when Returns Are Predictable," Journal of Finance, American Finance Association, vol. 55(1), pages 225-264, February.
    43. Edward Nelling & Joseph Gyourko, 1998. "The Predictability of Equity REIT Returns," Journal of Real Estate Research, American Real Estate Society, vol. 16(3), pages 251-268.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Aharon, David Y. & Ali, Shoaib & Brahim, Mariem, 2024. "Connectedness at extremes between real estate tokens and real estate stocks," International Review of Financial Analysis, Elsevier, vol. 95(PB).
    2. Kees de Van & Daniele Fano & Herialt Mens & Giovanna Nicodano, 2014. "A Reporting Standard for Defined Contribution Pension Plans," CeRP Working Papers 143, Center for Research on Pensions and Welfare Policies, Turin (Italy).
    3. Massimo Guidolin & Alexei G. Orlov, 2022. "Can Investors Benefit from Hedge Fund Strategies? Utility-Based, Out-of-Sample Evidence," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 12(03), pages 1-61, September.
    4. Massimo Guidolin & Giovanna Nicodano, 2010. "Ex Post Portfolio Performance with Predictable Skewness and Kurtosis," Carlo Alberto Notebooks 191, Collegio Carlo Alberto.
    5. Massimo Guidolin & Manuela Pedio & Milena T. Petrova, 2023. "The Predictability of Real Estate Excess Returns: An Out-of-Sample Economic Value Analysis," The Journal of Real Estate Finance and Economics, Springer, vol. 67(1), pages 108-149, July.
    6. Mohamed Arouri & Duc Khuong Nguyen & Kuntara Pukthuanthong, 2014. "Diversification benefits and strategic portfolio allocation across asset classes: The case of the US markets," Working Papers 2014-294, Department of Research, Ipag Business School.
    7. Charles-Olivier Amédée-Manesme & Fabrice Barthélémy & Jean-Luc Prigent & Donald Keenan & Mahdi Mokrane, 2017. "Modified Sharpe Ratios in Real Estate Performance Measurement: Beyond the Standard Cornish Fisher Expansion," THEMA Working Papers 2017-20, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    8. Yanotti, Maria B. & Kangogo, Moses & Wright, Danika & Sarkar, Somwrita & Lyu, Fei, 2024. "House price dynamics and internal migration across Australia," SocArXiv r5eg2, Center for Open Science.
    9. Cherif Famara Badji & Cristiane Benetti & Renato Guimaraes, 2021. "Diversification Benefits of European REIT, Equities and Bonds," Post-Print hal-03592183, HAL.
    10. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2010. "1/N and Long Run Optimal Portfolios: Results for Mixed Asset Menus," Carlo Alberto Notebooks 190, Collegio Carlo Alberto.
    11. Fabio C. Bagliano & Carolina Fugazza & Giovanna Nicodano, 2014. "Optimal Life-Cycle Portfolios for Heterogeneous Workers," Review of Finance, European Finance Association, vol. 18(6), pages 2283-2323.
    12. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2015. "Equally Weighted vs. Long†Run Optimal Portfolios," European Financial Management, European Financial Management Association, vol. 21(4), pages 742-789, September.
    13. Bonato, Matteo & Çepni, Oğuzhan & Gupta, Rangan & Pierdzioch, Christian, 2021. "Do oil-price shocks predict the realized variance of U.S. REITs?," Energy Economics, Elsevier, vol. 104(C).
    14. Mensi, Walid & Reboredo, Juan C. & Ugolini, Andrea & Vo, Xuan Vinh, 2022. "Switching connectedness between real estate investment trusts, oil, and gold markets," Finance Research Letters, Elsevier, vol. 49(C).
    15. George Yungchih Wang, 2012. "Evaluating an Investment Project in an Incomplete Market," The Review of Finance and Banking, Academia de Studii Economice din Bucuresti, Romania / Facultatea de Finante, Asigurari, Banci si Burse de Valori / Catedra de Finante, vol. 4(1), pages 055-073, June.
    16. Migliavacca, Milena & Goodell, John W. & Paltrinieri, Andrea, 2023. "A bibliometric review of portfolio diversification literature," International Review of Financial Analysis, Elsevier, vol. 90(C).
    17. Colin Lizieri & Gianluca Marcato & Paul Ogden & Andrew Baum, 2012. "Pricing Inefficiencies in Private Real Estate Markets Using Total Return Swaps," The Journal of Real Estate Finance and Economics, Springer, vol. 45(3), pages 774-803, October.
    18. Agyemang, Abraham & Chowdhury, Iftekhar & Balli, Faruk, 2021. "Quantifying Return Spillovers in Global Real Estate Markets," Journal of Housing Economics, Elsevier, vol. 52(C).
    19. Yener Cos‚kun & A. Sevtap Selcuk-Kestel & Bilgi Yilmaz, 2017. "Diversification benefit and return performance of REITs using CAPM and Fama-French: Evidence from Turkey," Borsa Istanbul Review, Research and Business Development Department, Borsa Istanbul, vol. 17(4), pages 199-215, December.
    20. Salisu, Afees A. & Akinsomi, Omokolade & Ametefe, Frank Kwakutse & Hammed, Yinka S., 2024. "Gold market volatility and REITs' returns during tranquil and turbulent episodes," International Review of Financial Analysis, Elsevier, vol. 95(PA).
    21. Paul M Anglin & Yanmin Gao, 2011. "Integrating Illiquid Assets into the Portfolio Decision Process," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 39(2), pages 277-311, June.
    22. Daniele Bianchi & Massimo Guidolin, 2014. "Can Linear Predictability Models Time Bull and Bear Real Estate Markets? Out-of-Sample Evidence from REIT Portfolios," The Journal of Real Estate Finance and Economics, Springer, vol. 49(1), pages 116-164, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2007. "Investing for the Long-run in European Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 34(1), pages 35-80, January.
    2. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2010. "1/N and long run optimal portfolios: results for mixed asset menus," Working Papers 2010-003, Federal Reserve Bank of St. Louis.
    3. Massimo Guidolin & Giovanna Nicodano, 2010. "Ex Post Portfolio Performance with Predictable Skewness and Kurtosis," Carlo Alberto Notebooks 191, Collegio Carlo Alberto.
    4. Yufeng Han, 2010. "On the Economic Value of Return Predictability," Annals of Economics and Finance, Society for AEF, vol. 11(1), pages 1-33, May.
    5. Daniel Giamouridis & Athanasios Sakkas & Nikolaos Tessaromatis, 2017. "Dynamic Asset Allocation with Liabilities," European Financial Management, European Financial Management Association, vol. 23(2), pages 254-291, March.
    6. Jakub W. Jurek & Luis M. Viceira, 2011. "Optimal Value and Growth Tilts in Long-Horizon Portfolios," Review of Finance, European Finance Association, vol. 15(1), pages 29-74.
    7. Wachter, Jessica A. & Warusawitharana, Missaka, 2009. "Predictable returns and asset allocation: Should a skeptical investor time the market?," Journal of Econometrics, Elsevier, vol. 148(2), pages 162-178, February.
    8. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2015. "Equally Weighted vs. Long†Run Optimal Portfolios," European Financial Management, European Financial Management Association, vol. 21(4), pages 742-789, September.
    9. Pettenuzzo, Davide & Timmermann, Allan, 2011. "Predictability of stock returns and asset allocation under structural breaks," Journal of Econometrics, Elsevier, vol. 164(1), pages 60-78, September.
    10. Guidolin, Massimo & Timmermann, Allan, 2007. "Asset allocation under multivariate regime switching," Journal of Economic Dynamics and Control, Elsevier, vol. 31(11), pages 3503-3544, November.
    11. Jessica A. Wachter, 2010. "Asset Allocation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 175-206, December.
    12. Shanken, Jay & Tamayo, Ane, 2012. "Payout yield, risk, and mispricing: A Bayesian analysis," Journal of Financial Economics, Elsevier, vol. 105(1), pages 131-152.
    13. Pettenuzzo, Davide & Timmermann, Allan & Valkanov, Rossen, 2014. "Forecasting stock returns under economic constraints," Journal of Financial Economics, Elsevier, vol. 114(3), pages 517-553.
    14. Mark E. Wohar & David E. Rapach, 2005. "Return Predictability and the Implied Intertemporal Hedging Demands for Stocks and Bonds: International Evidence," Computing in Economics and Finance 2005 329, Society for Computational Economics.
    15. Penaranda, Francisco, 2007. "Portfolio choice beyond the traditional approach," LSE Research Online Documents on Economics 24481, London School of Economics and Political Science, LSE Library.
    16. Marco Aiolfi & Carlo Ambrogio Favero, "undated". "Model Uncertainty, Thick Modelling and the predictability of Stock Returns," Working Papers 221, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    17. Spierdijk, Laura & Umar, Zaghum, 2014. "Stocks for the long run? Evidence from emerging markets," Journal of International Money and Finance, Elsevier, vol. 47(C), pages 217-238.
    18. Roel van Elk & Marc van der Steeg & Dinand Webbink, 2013. "The effects of a special program for multi-problem school dropouts on educational enrolment, employment and criminal behaviour; Evidence from a field experiment," CPB Discussion Paper 241.rdf, CPB Netherlands Bureau for Economic Policy Analysis.
    19. Maenhout, Pascal J., 2006. "Robust portfolio rules and detection-error probabilities for a mean-reverting risk premium," Journal of Economic Theory, Elsevier, vol. 128(1), pages 136-163, May.
    20. Rapach, David E. & Wohar, Mark E., 2009. "Multi-period portfolio choice and the intertemporal hedging demands for stocks and bonds: International evidence," Journal of International Money and Finance, Elsevier, vol. 28(3), pages 427-453, April.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • L85 - Industrial Organization - - Industry Studies: Services - - - Real Estate Services

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:reesec:v:37:y:2009:i:3:p:341-381. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/areueea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.