Gains from Diversifying into Real
Estate: Three Decades of Portfolio Returns Based on the Dynamic Investment
Robert Grauer and Nils H. Hakansson
The Journal of Finance, 23, Summer 1995, 117 159.
This paper compares the investment policies and returns for portfolios of stocks
and bonds with and without up to three categories of real estate. Both domestic
and global settings are examined, with and without the possibility of leverage.
The portfolios were generated via the dynamic investment model based on the
empirical probability assessment approach applied to past (joint) realizations
of returns, both with and without correction for "smoothing" in the real estate
data series. Our principal findings are: (1) the gains from adding real estate,
on a semi-passive (equal-weighted) basis, to portfolios of either U.S. or global
financial assets were relatively modest; in contrast, (2) the gains from adding
real estate to the universe of U.S. financial assets under an active strategy were
rather large (in some cases highly statistically significant), especially for the
very risk-averse strategies; (3) the gains from adding U.S. real estate to a
universe of global financial assets under an active strategy were mixed, although
generally favorable for the highly risk-averse strategies; (4) correcting for
second-moment smoothing in the real estate returns series had a relatively small
impact for the more risk-tolerant strategies; and (5) there was some evidence that
desmoothing resulted in improved probability estimates.
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