Unbiased Return on Art
For an illiquid asset class such as art, many individual assets do not trade within commonly used return measurement intervals (such as a year). When a relatively few works of art account for most of the trading, measured returns derive mostly from these few works. If the returns for frequently and seldom traded art differ, there would be a disconnect between measured returns and overall asset class performance. In the June 2013 version of their draft paper entitled “Does it Pay to Invest in Art? A Selection-corrected Returns Perspective”, Arthur Korteweg, Roman Kraussl and Patrick Verwijmeren examine such sample selection bias for art (paintings) as an asset class. Using a sample of 20,538 paintings sold 42,548 times at auction during 1972 through 2010, they find that:
The following chart, taken from the paper, shows the effect of correcting for selection bias on a gross price index for all paintings in the sample, normalized to a value of 100 in 1972. The uncorrected (No selection) index exhibits relatively strong growth over the sample period. Correcting for selection bias in three ways (Models A, B and C) substantially lowers index performance....MORE
- Paintings that trade more frequently exhibit higher price appreciation, thereby biasing estimates of asset class returns at commonly used measurement intervals (see the chart below).
- Correcting for this selection bias reduces the average annual gross return across all paintings in the sample from 11% to 7%, and the gross annual Sharpe ratio from 0.4 to 0.1 during 1972 through 2010. It changes the correlation of returns with equities from negative to about zero.
- Implications for asset class allocations are:
- Based on uncorrected (biased) statistics, a mean-variance investor would allocate twice as much to art as to stocks and achive a gross annual portfolio Sharpe ratio of 0.5 (compared to 0.3 for stocks alone).
- After correcting for bias, a mean-variance investor would allocate less than half to art than to stocks, with no meaningful improvement in gross portfolio Sharpe ratios compared to stocks alone.
- Accounting for high trading frictions, costs of insurance and physical security, and risk of forgeries further weakens the case for art as an investment. Non-monetary enjoyment of art is mitigating.
