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Time and risk diversification in real estate investments: assessing the ex post economic value

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  • Carolina Fugazza
  • Massimo Guidolin
  • Giovanna Nicodano

Abstract

Welfare gains to long-horizon investors may derive from time diversification that exploits non-zero 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 paper evaluates ex post, out-of-sample gains from diversification when E-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 doubts on the value of time diversification.

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  • Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2009. "Time and risk diversification in real estate investments: assessing the ex post economic value," Working Papers 2009-001, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2009-001
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    2. 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.
    3. 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.
    4. 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.
    5. 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.
    6. 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.
    7. 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.
    8. Massimo Guidolin & Alexei G. Orlov, 2018. "Can Investors Benefit from Hedge Fund Strategies? Utility-Based, Out-of-Sample Evidence," BAFFI CAREFIN Working Papers 1887, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    9. 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.
    10. 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.
    11. 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.
    12. Massimo Guidolin & Giovanna Nicodano, 2010. "Ex Post Portfolio Performance with Predictable Skewness and Kurtosis," Carlo Alberto Notebooks 191, Collegio Carlo Alberto.
    13. Massimo Guidolin & Manuela Pedio & Milena Petrova, 2019. "The Predictability of Real Estate Excess Returns: An Out-of-Sample Economic Value Analysis," BAFFI CAREFIN Working Papers 19122, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    14. 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).
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    More about this item

    Keywords

    Real estate investment;

    JEL classification:

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

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