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Optimal allocation to real estate incorporating illiquidity risk

Author

Listed:
  • Shaun A Bond

    (University of Cambridge)

  • Soosung Hwang

    (University of Cambridge)

  • Kimberley Richards

    (University of Cambridge)

Abstract

This paper considers how the illiquidity risk associated with the uncertain marketing period of a commercial property affects the allocation to real estate assets in a mixed-asset portfolio. Using the model of marketing period risk discussed by Bond et al. (‘Marketing Period Risk in a Portfolio Context: Theory and Empirical Estimates from the UK Commercial Real Estate Market’, mimeo, Department of Land Economy, University of Cambridge, 2005) and UK asset return data, the study finds that the allocations to real estate in a portfolio with a short holding period (one year) fall dramatically following the incorporation of the illiquidity risk into the analysis. For longer holding period portfolios (five years), however, the impact of the illiquidity risk on portfolio allocation is less significant. The results do not explain the large discrepancy between observed portfolio allocations to real estate and the allocations suggested from standard mean-variance models. Illiquidity risk appears to be a contributing factor, but it is not the main driver of low actual allocations to real estate in UK pension funds.

Suggested Citation

  • Shaun A Bond & Soosung Hwang & Kimberley Richards, 2006. "Optimal allocation to real estate incorporating illiquidity risk," Journal of Asset Management, Palgrave Macmillan, vol. 7(1), pages 2-16, May.
    • Handle: RePEc:pal:assmgt:v:7:y:2006:i:1:d:10.1057_palgrave.jam.2240197
    DOI: 10.1057/palgrave.jam.2240197
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    Cited by:

    1. Heinrich, Michael & Just, Tobias & Schreck, Thomas, . "Auswirkungen von Solvency II auf die Immobilienanlagen europäischer Versicherer," Beiträge zur Immobilienwirtschaft, University of Regensburg, Department of Economics, number 12, August.
    2. Bouteska, Ahmed & Sharif, Taimur & Abedin, Mohammad Zoynul & Ghouli-Oueslati, Jihene, 2023. "Relocating investments by Tunisian insurance and pension funds towards alternative assets opportunities," Journal of Policy Modeling, Elsevier, vol. 45(3), pages 609-629.
    3. Michael Heinrich & Thomas Schreck, 2017. "Effects of Solvency II on Portfolio Efficiency, The Case of Real Estate and Infrastructure Investments," LARES lares_2017_paper_8, Latin American Real Estate Society (LARES).
    4. Just, Tobias & Möbert, Jochen & Heinrich, Michael, . "Deutsche Wohnimmobilien als Kapitalanlage : Gutachten im Auftrag der Deutsche Bank Privat- und Geschäftskunden AG," Beiträge zur Immobilienwirtschaft, University of Regensburg, Department of Economics, number 6, August.

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