Real Estate in an Alm Framework: The Case of Fair Value Accounting
Erasmus University Rotterdam (EUR) - Department of Financial Management; Erasmus Research Institute of Management (ERIM); Tinbergen Institute
Melissa Porras Prado
Nova School of Business and Economics
Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM); Netspar
Real Estate Economics, Vol. 38, No. 4, pp. 775-804, 2010
This study examines the liability hedging characteristics of both direct and indirect real estate with the advent of fair value accounting obligations for pension funds. We explicitly model pension obligations as being subject to interest and inflation risk to analyze the ability of real estate investments in hedging the fair value of pension liabilities and to quantify its role in an asset liability management (ALM) portfolio. We find that the portfolio composition differs depending on the definition of liability return. When liability returns solely follow actuarial changes, the mean-variance efficient portfolio allocations toward direct real estate and fixed income decrease compared to the asset-only optimization. When accounting for nominal liability obligations, real estate offers hedging benefits against interest rates for short holding periods but not for long-term institutional portfolios. The inclusion of inflation risk renders a limited role for direct real estate in an ALM portfolio, while indirect real estate obtains no allocation. Inflation is at the heart of the discrepancy between reported and predicted pension plan allocations. Once accounting for inflation, the projected allocations come close to reported ones.
Number of Pages in PDF File: 30
Date posted: January 3, 2011
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