Real Estate Allocation Puzzle in the Mixed-Asset Portfolio: Fact or Fiction?

22 Pages Posted: 3 Apr 2010

See all articles by Ping Cheng

Ping Cheng

Florida Atlantic University - Finance

Zhenguo (Len) Lin

Florida International University (FIU) - Hollo School of Real Estate

Yingchun Liu

Dept. of Finance, Insurance, Real Estate and Law, University of North Texas

Yongmin Zhang

Xi'an Jiaotong University (XJTU) - Department of Mathematical Sciences

Date Written: February 3, 2010

Abstract

Direct application of Modern Portfolio Theory (MPT) to the mixed-asset portfolio often suggests that allocation to real estate should be far more than what is practically acceptable. This paper reveals that the puzzling gap is caused by inappropriate application of MPT using only short-term (quarterly or annual) real estate performance measures. Our findings suggest that (1) the validity of MPT (the single-period model) to multi-period real estate investment is critically conditional upon the assumption that asset returns over time are independent and identically distributed (i.i.d.), and (2) the i.i.d. condition is strongly rejected by real estate data. As a result, real estate return and risk are holding-period dependent. We show that once real estate performance is measured over more realistic holding periods - which are longer due to illiquidity and high transaction cost - the real estate allocation puzzle appears to be fiction rather than fact.

Keywords: Mixed-Asset Portfolio, Asset Allocation, Real Estate

Suggested Citation

Cheng, Ping and Lin, Zhenguo and Liu, Yingchun and Zhang, Yongmin, Real Estate Allocation Puzzle in the Mixed-Asset Portfolio: Fact or Fiction? (February 3, 2010). Available at SSRN: https://ssrn.com/abstract=1583952 or http://dx.doi.org/10.2139/ssrn.1583952

Ping Cheng

Florida Atlantic University - Finance ( email )

777 Glades Rd
Boca Raton, FL 33431
United States
561-297-3456 (Phone)
561-297-3686 (Fax)

Zhenguo Lin (Contact Author)

Florida International University (FIU) - Hollo School of Real Estate ( email )

Miami, FL 33199
United States
3057799248 (Phone)

Yingchun Liu

Dept. of Finance, Insurance, Real Estate and Law, University of North Texas ( email )

1155 Union Circle #305340
Denton, TX 76203
United States

Yongmin Zhang

Xi'an Jiaotong University (XJTU) - Department of Mathematical Sciences ( email )

111 Ren Ai Road
Dushu Lake Higher Education Town
Suzhou, Jiangsu 215123
China

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