Department of Economics and Finance Art – A purely emotional Asset? Diversification potential of art in an equity setting. SUPERVISOR Prof. Nicola Borri CANDIDATE Laura Pollmann 705801 CO-SUPERVISOR Prof. Benigno Pierpaolo Academic Year 2018/2019 “When bankers get together, they talk about art. When artists get together, they talk about money.” ― Oscar Wilde Table of Contents Overview of Equations 6 Overview of Figures 6 Overview of Tables 6 Index of Abbreviations 7 Introduction 9 1. Art as a New Asset Class 13 1.1 Art vs. Alternative Asset Classes ......................................................................................................... 14 1.1.1 Average and Optimal Holding Period ..................................................................................... 15 1.1.2 Pricing Anchors ....................................................................................................................... 16 1.1.3 Price Elasticity ......................................................................................................................... 21 1.1.4 Benchmarking .......................................................................................................................... 22 1.1.5 Co-Movements: Benefits of Diversification and Hedging Inflation ........................................ 24 1.1.6 Legal Aspects ........................................................................................................................... 26 1.2 Art Market (In)Efficiency .................................................................................................................... 28 1.2.1 Allocational and Informational Efficiency ............................................................................... 28 1.2.2 Capital Controls and Institutional Efficiency .......................................................................... 30 1.2.3 Liquidity Aspects ...................................................................................................................... 31 1.3 Art Market Actors ................................................................................................................................ 32 1.3.1 Art Dealers ............................................................................................................................... 32 1.3.2 Auction Houses ........................................................................................................................ 33 1.3.3 Art Fairs, Museums and Exhibitions ....................................................................................... 35 1.3.4 Investors and Speculators ........................................................................................................ 35 1.3.5 Financial Services .................................................................................................................... 36 1.3.6 Clicks and Mortar: The Online Art Market ............................................................................. 37 1.4 Peripheral Fees & Other Rate of Return Determinants ....................................................................... 38 1.4.1 Risks ......................................................................................................................................... 38 1.4.2 Commissions and Shipping Costs ............................................................................................ 39 1.4.3 Insurance & Maintenance Costs .............................................................................................. 39 1.4.4 Taxation ................................................................................................................................... 40 1.4.5 Aesthetic Return ....................................................................................................................... 41 1.4.6 Securitization ........................................................................................................................... 42 1.5 Art Price Indices Computation ............................................................................................................. 43 1.5.1 Naïve Indices and Geometric Mean ......................................................................................... 44 1.5.2 Hedonic and Repeated Sales Regression ................................................................................. 45 1.6 Returns Found in Existing Literature ................................................................................................... 48 1.7 Assessment of Available Data ............................................................................................................. 52 1.7.1 Possible Information Sources .................................................................................................. 52 1.7.2 Potential Biases in Auction Records ........................................................................................ 53 2. Investment Opportunities: Art Investment Funds 55 2.1 Conception ........................................................................................................................................... 55 2.2 Strategies .............................................................................................................................................. 56 2.3 Genesis ................................................................................................................................................. 57 2.4 Open-End vs. Closed-End Art Funds ................................................................................................... 58 2.5 Funds Management and Regulation ..................................................................................................... 58 2.6 Fee Structure ........................................................................................................................................ 60 2.7 Investor Relations ................................................................................................................................ 60 2.8 Performance Evaluation – In Theory ................................................................................................... 61 2.9 The Good, The Bad and The Ugly – Performance in Practice ............................................................ 64 2.10 Case Study: Tiroche DeLeon ............................................................................................................... 65 2.11 Advantages and Limitations ................................................................................................................ 66 2.11.1 Diversification and Economies of Scale ................................................................................ 66 2.11.2 Expertise and Infrastructure .................................................................................................. 67 2.11.3 Moral Hazard ........................................................................................................................ 67 2.11.4 Information Asymmetry and Lack of Regulation ................................................................... 68 2.11.5 Conflicts of Interests .............................................................................................................. 68 2.11.6 Illiquidity ................................................................................................................................ 68 2.12 Current Condition of the Art Fund Industry ........................................................................................ 69 3. Art Market Performance and Portfolio Diversification 72 3.1 Approach and Underlying Data ........................................................................................................... 72 3.2 Art Market Performance ...................................................................................................................... 74 3.2.1 Risk - Reward Relationship ...................................................................................................... 74 3.2.2 Correlations Amongst Art Categories ..................................................................................... 75 3.2.3 Principal Component Analysis ................................................................................................ 76 3.2.4 Exclusively Art Portfolios: Naïve vs. Volatility-Timing Strategy ............................................ 79 3.2.5 Minimum Variance Portfolios .................................................................................................. 81 3.2.6 Value at Risk, Expected Shortfall and Securitization Aspects ................................................. 82 3.3 Equity Investments ............................................................................................................................... 83 3.3.1 Downside Risks ........................................................................................................................ 88 3.4 Mixed Asset Portfolio .......................................................................................................................... 88 3.4.1 Correlations between Art and Equities .................................................................................... 89 3.4.2 Diversification Benefits of Art in an Equity Setting ................................................................. 89 3.5 Hedging Inflation ................................................................................................................................