Smoothing and Implications for Asset Allocation Choices

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. In this article, the authors focus 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 studies. They 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. The authors 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. The empirical results reported are in line with previous studies with respect to the level of the unsmoothing parameter. Moreover, current weights of asset classes in institutional portfolios suggest a parameter maximzsing the portfolio's Sharpe ratio similar to the one identified in other studies. This result also has implications for the implied volatility of real estate markets.