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An Analysis of Commercial Real Estate Returns: Is there a Smoothing Puzzle?

Speaker: Dr. Shaun Bond, Department of Land Economy, University of Cambridge, UK

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The reduction in global interest rates and the poor performance of stock markets in recent years has seen investors turn to less liquid assets in order to maintain yield or support carry trades. Attention has increasingly focused on asset classes such as commercial real estate, emerging market bonds and hedge funds. However one difficulty for investors in these markets is that readily observable measures of performance based on transactions are not always available. As an example, indices based on infrequent estimates of market price (appraisals) are widely used to measure performance in the commercial real estate sector in contrast to the equity or bond markets, where minute by minute transactions data exists. When current transaction prices for an asset are not readily observed it is necessary to infer market values from the evidence available.

In this paper a key econometric question related to non-transaction based return indices, such as real estate indices, is explored. Using a sample of individual property level returns data from the Investment Property Database (IPD) in the UK, we investigate the relationship between persistence (smoothing) at the individual property level and the amount of persistence in the aggregate appraised-based index. We find that commonly used adjustments to correct index level returns overstate the extent of persistence (smoothing) found at the individual property level. We also find strong support for an ARFIMA representation of appraisal returns in the UK. Our approach may have applications in many areas of finance as it could help to understand other indices such as hedge fund (for example, Getmansky, Lo, and Makarov, 2004), consumer confidence, business survey, or market sentiment indices. Many of these indices suffer similar econometric problems to those investigated in this paper though the effects of each of these issues may differ.

15 August 2006
City - Haymarket CB05D Level 3, Room 3.01
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