Industrial Real Estate Investment: Does the Contrarian Strategy Work?

The superiority of the contrarian investment strategy, though well attested to in the finance literature, has received scant attention, if any, in the real estate literature. This study uses empirical industrial real estate investment return data from 1985Q1 to 2005Q3 for the US, and some Asia Pacific cities in order to ascertain the relative superiority of “value” and “growth” industrial real estate investments. The results show that “value” industrial property investment outperformed “growth” industrial property investment in all the holding periods under consideration. Furthermore the industrial property investments exhibit return reversal. This implies that the superiority of the contrarian strategy is sustainable. The results of stochastic dominance tests validate the relative superiority of “value” over “growth” industrial property investment. This implies that fund managers who traditionally have been favoring prime (i.e. growth) industrial property investment may have to reconsider their investment strategy if they want to maximize their return.     

Public Investment Criteria in Overlapping Generations Models of Open Economies

This paper derives criteria for worthwhile public investment in an overlapping generations model of an “almost small” open economy- an economy with access to external funding at a given interest rate, but with some influence over its temporal terms of trade. If the economy is dynamically efficient (i.e. the interest rate exceeds the growth rate), committed to free trade, public investment is debt financed and lump sum taxes are feasible, two results follow. First, the “social opportunity cost of public funds” will exceed the government's borrowing rate because of the adverse effect of government borrowing on the terms of trade. Second, the marginal rate of return on worthwhile public investment will be greater than the social opportunity cost of public funds if public and private investment are complements (substitutes) and the tax on capital is below (above) the rate that minimizes the steady state burden of servicing the debt. JEL Code: F21, H43     

Consistent price systems and arbitrage opportunities of?the?second kind in models with transaction costs

In contrast with the classical models of frictionless financial markets, market models with proportional transaction costs, even satisfying usual no-arbitrage properties, may admit arbitrage opportunities of the second kind. This means that there are self-financing portfolios with initial endowments lying outside the solvency region but ending inside. Such a phenomenon was discovered by M. Rásonyi in the discrete-time framework. In this note, we consider a rather abstract continuous-time setting and prove necessary and sufficient conditions for a property which we call no free lunch of the second kind, NFL2. We provide a number of equivalent conditions elucidating, in particular, the financial meaning of the property B which appeared as an indispensable “technical” hypothesis in previous papers on hedging (superreplication) of contingent claims under transaction costs. We show that it is equivalent to another condition on the “richness” of the set of consistent price systems, close to the condition PCE introduced by Rásonyi. In the last section, we deduce the Rásonyi theorem from our general result by using specific features of discrete-time models.     

Home Price,Time-on-Market,and Seller Heterogeneity Under Changing Market Conditions

This paper develops a formal model to examine the effect of changing market conditions and individuals’ selling constraints on selling price and time-on-market. Using the concept of Relative Liquidity Constraint (RLC)—a stochastic variable that captures the randomness of future individual constraints and market conditions—the study presents the first ex ante analysis that extends the investigation of the issue of seller heterogeneity to the point of the buying decision, that is, from the perspective of the buyer’s (future seller’s) point of view. We show that seller constraint, as well as the uncertainty of such a constraint, significantly depresses the expected selling price and increases risk. Our closed-form formulas provide a set of simple quantitative tools that enable buyers and sellers to adjust the “market average” to their ex ante “individual expectations”.     

No-arbitrage in Discrete-time Markets with Proportional Transaction Costs and General Information structure

We discuss the no-arbitrage conditions in a general framework for discrete-time models of financial markets with proportional transaction costs and general information structure. We extend the results of Kabanov et al. (Finance Stoch 6(3):371–382, 2002; Finance Stoch 7(3):403–411, 2003) and Schachermayer (Math Finance 14(1):19–48, 2004) to the case where bid-ask spreads are not known with certainty. In the “no-friction” case, we retrieve the result of Kabanov and Stricker (Preprint 2003). Additionally, we propose a new modelization based on simple orders which appears to be powerful whatever the information structure is.     

Risk-neutral compatibility with option prices

A common problem is to choose a “risk-neutral” measure in an incomplete market in asset pricing models. We show in this paper that in some circumstances it is possible to choose a unique “equivalent local martingale measure” by completing the market with option prices. We do this by modeling the behavior of the stock price X, together with the behavior of the option prices for a relevant family of options which are (or can theoretically be) effectively traded. In doing so, we need to ensure a kind of “compatibility” between X and the prices of our options, and this poses some significant mathematical difficulties.     

A Quarterly Transactions-based Index of Institutional Real Estate Investment Performance and Movements in Supply and Demand

This article presents a methodology for producing a quarterly transactions-based index (TBI) of property-level investment performance for U.S. institutional real estate. Indices are presented for investment periodic total returns and capital appreciation (or price-changes) for the major property types included in the NCREIF Property Index. These indices are based on transaction prices to avoid appraisal-based sources of index “smoothing” and lagging bias. In addition to producing variable-liquidity indices, this approach employs the Fisher-Gatzlaff-Geltner-Haurin (Real Estate Econ., 31: 269–303, 2003) methodology to produce separate indices tracking movements on the demand and supply sides of the investment market, including a “constant-liquidity” (demand side) index. Extensions of Bayesian noise filtering techniques developed by Gatzlaff and Geltner (Real Estate Finance, 15: 7–22, 1998) and Geltner and Goetzmann (J. Real Estate Finance Econ., 21: 5–21, 2000) are employed to allow development of quarterly frequency, market segment specific indices. The hedonic price model used in the indices is based on an extension of the Clapp and Giacotto (J. Am. Stat. Assoc., 87: 300–306, 1992) “assessed value method,” using a NCREIF-reported recent appraised value of each transacting property as the composite “hedonic” variable, thus allowing time-dummy coefficients to represent the difference each period between the (lagged) appraisals and the transaction prices. The index could also be used to produce a mass appraisal of the NCREIF property database each quarter, a byproduct of which would be the ability to provide transactions price based “automated valuation model” estimates of property value for each NCREIF property each quarter. Detailed results are available at .     

Balance,growth and diversity of financial markets

A financial market comprising of a certain number of distinct companies is considered, and the following statement is proved: either a specific agent will surely beat the whole market unconditionally in the long run, or (and this “or” is not exclusive) all the capital of the market will accumulate in one company. Thus, absence of any “free unbounded lunches relative to the total capital” opportunities lead to the most dramatic failure of diversity in the market: one company takes over all other until the end of time. In order to prove this, we introduce the notion of perfectly balanced markets, which is an equilibrium state in which the relative capitalization of each company is a martingale under the physical probability. Then, the weaker notion of balanced markets is discussed where the martingale property of the relative capitalizations holds only approximately, we show how these concepts relate to growth-optimality and efficiency of the market, as well as how we can infer a shadow interest rate that is implied in the economy in the absence of a bank.      

Analysis of efficient markets

A simple trading model is presented in which Bayes’ rule is used to aggregate traders’ forecasts about risky assets’ future returns. In this financial market, Bayes’ rule operates like an omnipotent market-maker performing functions that in 1776 Adam Smith attributed to an “invisible hand.” We have analyzed two distinct cases: in the first scenario, the traders’ forecast errors are uncorrelated, and in the second scenario, the traders’ forecast errors are correlated. The contribution of our paper is fourfold: first, we prove that the “efficient market” mean-return can be expressed as a complex linear combination of the traders’ forecasts. The weights depend on the forecast variances, as well as on the correlations among the traders’ forecasts. Second we show that the “efficient” variance is equal to the inverse of the sum of the traders’ precision errors, and is also related to the correlations among the traders’ forecast errors. Third, we prove that the efficient market return is the best linear minimum variance estimator (BLMVE) of the security’s mean return (in the sense that it minimizes the sum of the traders’ mean squared forecast errors). Thus, an efficient market aggregates traders’ heterogeneous information in an optimal way. Fourth, we prove that an efficient market produces a mean return (price) as a Blackwell sufficient (most informative) experiment among all possible aggregated expected return (price) forecasts.     

Office Building Capitalization Rates: The Case of Downtown Chicago

This paper is an empirical study of the capitalization rates for 132 office building sales in downtown Chicago from 1996 to 2007. The capitalization rate is hypothesized to be a function of the classic capital asset pricing model variable and variables intended to capture the expectation that the real market value of the building will change. The results show that the capitalization rate for office buildings incorporates a very low value for “beta.” A lower capitalization rate was associated with a smaller risk-free rate, a lower borrowing rate, class A buildings, newer buildings, buildings that had been renovated, a reduction in the vacancy rate in the downtown Chicago office market, and an increase in employment in the financial sector of the metropolitan area.     

Estimating the term structures of corporate debt

This paper investigates the corporate bond market by estimating monthly interest rate term structures for investment grade credit classes using both S&P's and Moody's ratings. Term structures are modeled by a piecewise constant forward rate curve and estimated on noncallable coupon paying bonds issued by industrial firms. The iterative estimation algorithm minimizes the sum of squared errors between market prices and model prices while identifying and removing outliers from the sample. Although the forward rate model is successful at pricing corporate debt, additional factors are found to be significant at explaining the residual price error that remains after the forward rate model is fit to market prices. Six necessary no-arbitrage conditions are derived for the term structures of risky and risk-free debt. Occasionally, some of these no-arbitrage conditions are violated and a few violations are asymptotically statistically significant. Finally, trading strategies that capture mispricing in the corporate debt market and violations of no-arbitrage bounds are discussed.This paper was adapted from my dissertation, completed at Cornell University. An earlier version of this paper was titled The Term Structures of Corporate Debt. Thanks to participants at the Cornell University finance workshop, Warren Bailey, Peter Carr, Antoine Giannetti, and especially Robert Jarrow for their helpful comments.     

How arbitrage-free is the Nelson-Siegel model?

We test whether the Nelson and Siegel (1987) yield curve model is arbitrage-free. Theoretically, the Nelson-Siegel model does not ensure the absence of arbitrage opportunities, as shown by Bjork and Christensen (1999) and Filipovic (1999). Still, central banks and wealth managers rely heavily on it. Using zero-coupon yield curve data from the US market, we find that the no-arbitrage parameters are not statistically different from those obtained from the Nelson-Siegel model. We therefore conclude that the Nelson-Siegel yield curve model is compatible with the no-arbitrage constraints on the US market. To corroborate this result, we also show that the Nelson-Siegel model performs as well as its no-arbitrage counterpart in an out-of-sample forecasting experiment.     

The numéraire portfolio in semimartingale financial models

We study the existence of the numéraire portfolio under predictable convex constraints in a general semimartingale model of a financial market. The numéraire portfolio generates a wealth process, with respect to which the relative wealth processes of all other portfolios are supermartingales. Necessary and sufficient conditions for the existence of the numéraire portfolio are obtained in terms of the triplet of predictable characteristics of the asset price process. This characterization is then used to obtain further necessary and sufficient conditions, in terms of a no-free-lunch-type notion. In particular, the full strength of the “No Free Lunch with Vanishing Risk” (NFLVR) condition is not needed, only the weaker “No Unbounded Profit with Bounded Risk” (NUPBR) condition that involves the boundedness in probability of the terminal values of wealth processes. We show that this notion is the minimal a-priori assumption required in order to proceed with utility optimization. The fact that it is expressed entirely in terms of predictable characteristics makes it easy to check, something that the stronger NFLVR condition lacks.      

The Optimal Choice for Lenders Facing Defaults: Short Sale,Foreclose, or REO

When mortgage borrowers default and have no desire or ability to keep their property, then loss mitigation involves a sale of the property via one of the following options: (1) the lender allows pre-foreclosure “short sale” by the borrower, (2) the lender institutes the foreclosure process under a notice of default and the property is sold during the process by the borrower, and (3) the lender forecloses on the property, takes title, and sells the property in the market as real estate owned (REO). Sale of the property in the above three options is conducted by a motivated seller, either the owner or the lender, who desires to sell the property as quickly as possible. Thus, relative to a no-default sale, the house is most likely to be sold at a discounted price. It is generally expected that the discount would be lower in the case of a “short sale.” This option, however, may result in a longer marketing time, thus a higher total loss, than the other two options. We developed a model that allows simultaneous estimation of price and time-on-market effects of “short sales,” foreclosures, and REO options. We find that the short-sale option has the lowest-price discount, but significantly higher costs associated with marketing time. The pattern of price discount and marketing time reverses as we move to a sale while in the process of foreclosure and to a sale with an REO status.     

A positive analysis of labor-market institutions and tax reforms

In this paper, we investigate the structure of the “Laffer curve” for taxes on labor and other factors of production, under different institutional frameworks of the labor market. Using a Cobb–Douglas production technology allows us to characterize important properties of the “Laffer curve” in terms of the wage share for a competitive labor market, the monopoly union model, the right-to-manage approach, the insider-dominated union, and efficient Nash bargains simultaneously. In this way, we are able to highlight the menu of factor tax systems, and thus of potential tax reforms available to a government, without perfect knowledge of the mechanism of the labor market. In particular, we show that the employment-maximizing tax system features a constant energy tax, while the energy mini-/maximizing tax system features a constant labor tax. We also illuminate to what extent these results must be modified if we either employ a CES production function, or if we allow for an endogenous reservation wage.