Real Estate in an Alm Framework: The Case of Fair Value Accounting

30 Pages Posted: 3 Jan 2011  

Dirk Brounen

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

Marno Verbeek

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM); Netspar

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Abstract

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.

Suggested Citation

Brounen, Dirk and Prado, Melissa Porras and Verbeek, Marno, Real Estate in an Alm Framework: The Case of Fair Value Accounting. Real Estate Economics, Vol. 38, No. 4, pp. 775-804, 2010. Available at SSRN: https://ssrn.com/abstract=1733776 or http://dx.doi.org/10.1111/j.1540-6229.2010.00283.x

Dirk Brounen (Contact Author)

Erasmus University Rotterdam (EUR) - Department of Financial Management ( email )

P.O. Box 1738
Room T09-53
3000 DR Rotterdam
Netherlands

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 1 0408 2371 (Phone)
+31 1 0408 9017 (Fax)

HOME PAGE: http://web.eur.nl/fbk/dep/dep5/faculty/dbrounen

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands
120-551-3535 (Phone)

Melissa Porras Prado

Nova School of Business and Economics ( email )

Campus de Campolide
Lisbon, 1099-032
Portugal

Marno Verbeek

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Room T09-53
3000 DR Rotterdam
Netherlands
+31 10 408 2790 (Phone)

HOME PAGE: http://www.rsm.nl/mverbeek

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Netspar

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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