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Investing for the Long-Run in European Real Estate. Does Predictability Matter?

  • Carolina Fugazza

    ()

    (Center for Research on Pensions and Welfare Policies)

  • Massimo Guidolin

    ()

    (Federal Reserve Bank of St. Louis)

  • Giovanna Nicodano

    ()

    (Department of Economics, University of Turin and Center for Research on Pensions and Welfare Policies, Turin)

We calculate optimal portfolio choices for a long-horizon, risk-averse European investor who diversifies among stocks, bonds, real estate, and cash, when excess asset returns are predictable. Simulations are performed for scenarios involving different risk aversion levels, horizons, and statistical models capturing predictability in risk premia. Importantly, under one of the scenarios, the investor takes into account the parameter uncertainty implied by the use of estimated coefficients to characterize predictability. We find that real estate ought to play a significant role in optimal portfolio choices, with weights between 10 and 30% in most cases. Under plausible assumptions, the welfare costs of either ignoring predictability or restricting portfolio choices to financial assets only are found to be in the order of at least 100 basis points per year. These results are robust to changes in the benchmarks and in the statistical framework.

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File Function: First version, 2005
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Paper provided by Center for Research on Pensions and Welfare Policies, Turin (Italy) in its series CeRP Working Papers with number 40.

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Length: 44 pages
Date of creation: Mar 2005
Date of revision:
Handle: RePEc:crp:wpaper:40
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