Smoothing and Implications for Asset Allocation Choices
35 Pages Posted: 11 Apr 2015
Date Written: April 28, 2007
Abstract
An extensive literature on smoothing issues in real estate markets has been published, covering a range of theoretical techniques, applications to indices and asset allocation. A recent paper by Geltner et al [2002] reviewed the main theoretical approaches to the construction of unsmoothing algorithms. This paper focuses on the practical implications of unsmoothing model selection and calibration for asset allocation decisions in the UK, US and Australian markets and sheds light upon contradictory results in previous literature – Stevenson [2004].
We find that different unsmoothing techniques yield very similar asset allocation choices. Identified portfolio weights are much more sensitive to the unsmoothing parameter than to the unsmoothing method. We conclude that research on smoothing should focus on the identification of the best parameter rather than on the specification of the model to be used. Finally our results are empirically in line with previous literature on the level of the unsmoothing parameter. Moreover current weights of asset classes in institutional portfolios suggest a parameter maximising the portfolio’s Sharpe ratio similar to the one identified in previous literature. This result has also an implication on the implied volatility of real estate markets.
Keywords: smoothing, asset allocation, real estate
Suggested Citation: Suggested Citation