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

Federal Reserve Bank of St. Louis Working Paper No. 2009-001A

35 Pages Posted: 15 Jan 2009

See all articles by Carolina Fugazza

Carolina Fugazza

University of Torino -Department of Economics ESOMAS; Center for Research on Pensions and Welfare Policies

Massimo Guidolin

Bocconi University, Dept. of Finance; Bocconi University - CAREFIN - Centre for Applied Research in Finance

Giovanna Nicodano

University of Turin - Department ESOMAS; Collegio Carlo Alberto; CEPR; EGCI; Netspar

Multiple version iconThere are 2 versions of this paper

Date Written: January 13, 2009

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.

Keywords: real time asset allocation, real estate, ex post performance, predictability, parameter uncertainty

JEL Classification: G11, L85

Suggested Citation

Fugazza, Carolina and Guidolin, Massimo and Nicodano, Giovanna, Time and Risk Diversification in Real Estate Investments: Assessing the Ex Post Economic Value (January 13, 2009). Federal Reserve Bank of St. Louis Working Paper No. 2009-001A, Available at SSRN: https://ssrn.com/abstract=1327461 or http://dx.doi.org/10.2139/ssrn.1327461

Carolina Fugazza

University of Torino -Department of Economics ESOMAS ( email )

Torino
Italy

Center for Research on Pensions and Welfare Policies ( email )

Torino
Italy

Massimo Guidolin (Contact Author)

Bocconi University, Dept. of Finance ( email )

Via Roentgen, 1
2nd floor
Milan, MI 20136
Italy

Bocconi University - CAREFIN - Centre for Applied Research in Finance

Via Sarfatti 25
Milan, 20136
Italy

Giovanna Nicodano

University of Turin - Department ESOMAS ( email )

Turin, 10134
Italy

HOME PAGE: http://https://www.carloalberto.org/person/giovanna-nicodano/

Collegio Carlo Alberto ( email )

Piazza Arbarello 8
Torino, Torino 10121
Italy
390116705006 (Phone)

HOME PAGE: http://https://www.carloalberto.org/person/giovanna-nicodano

CEPR ( email )

London
United Kingdom

EGCI ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands