HERIOT-WATT UNIVERSITY DUBAI CAMPUS
Research Proposal
| Title of Course and Code: |
Research Methods: C39RE |
| Course Lecturer: |
Dr. Esinath Ndiweni |
| Title of Course Work: |
The investment potential of art markets |
| Name of Student |
|
| Registration No: |
H00178570 |
| Program title |
BA Accountancy & Finance |
| Word Count: |
1976 words |
1) Dissertation Title
The investment potential of art markets
2) Background
Art in its various forms has been an essential part of human culture since prehistoric times. Nevertheless, a purposeful usage of artworks as means of investment is a relatively recent phenomenon that has started to attract more attention of investors as well as academics. This is partially fueled by the increasing need for profitable and diversified investments in the world where, some argue, there is more money to invest than attractive opportunities to absorb it. Despite a number of considerable articles published on the topic in the last 30 years, there is still a lack of evidence especially when comparing to the literature on other investment assets such as stocks or bonds. This might also be one of the reasons for misbeliefs about art markets that sometimes result to suboptimal investment decisions by unsophisticated individuals and companies.
The following dissertation contributes to the existing research on the topic by presenting results that to some extent are more relevant than those of a number of previous papers. First, the samples that it uses are more appropriate from the timing perspective as they capture the most recent years. Second, it pays sufficient attention on the forms of investment in art other than purchasing and selling individual artworks on auctions. This as well as some other features of this study make it potentially beneficial for different groups of readers including current and future investors.
3) Research Question, Aim and Objectives
3.1 Research Question
Can art be considered as suitable asset class for investment purposes?
3.2 Research Aim and Objectives
This dissertation aims to research and analyze the financial implications of investing in various artworks in order assess their potential attractiveness for investors.
The research addresses the following objectives:
1. To investigate the returns and risks of various forms of investing in art;
2. To compare risk-return profiles of artworks to those of other investment options;
3. To study the possibility of using art as a suitable diversification or hedging tool.
4) Potential impact of the dissertation
Although the majority of empirical evidence does not find investing in art to be more profitable than investing in other assets, additional research on the topic might still yield to a different result. First, due to limitations of some studies, poor risk-return figures of artworks might not be the case for some categories of art such as particular artistic movements, subject matters, schools or periods. In other words, a detailed research might still find the attractiveness of certain types of art as means of investment. Second, despite generally lower expected returns, art might still be worth investing in if it proves to be useful for diversification purposes. Correlation among international markets has increased from 50% – 60% in 1990s to over 90% after 2008, thus reducing the benefits of international diversification (Forbes, 2017). In the light of this as well as decreased effectiveness of diversification among different asset classes, finding the diversification potential of art markets becomes a more relevant field of investigation.
The findings of this dissertation can potentially benefit all readers who are interested in the topics of investments or art and especially those who might become potential investors in artworks but have currently a lack of understanding. There are still widespread misbeliefs about the art markets that usually result to overestimation of potential returns and underestimations of related risks. An additional recently published paper showing a more realistic picture can definitely serve as a good warning for unsophisticated potential investors. On the other hand, obtaining a result that is contrary to the majority of empirical evidence would also be an interesting experience for any researcher. Findings showing, at least to a certain extent, the attractiveness of investing in artworks could not only encourage further research than the opposite results would but could potentially benefit different individuals and organisations including art investors, collectors, auction houses and art funds.
A potential feature of this dissertation that is not present in many similar studies is taking into consideration foreign exchange rates when calculating the returns of investing in artworks. Doing this has become more relevant in the recent decade not only due to higher exchange fluctuations of USD, EUR and GPB but also due to increasing weight of China in art markets. Another characteristic of the research is higher focus on structured opportunities of investment in art as many of the previous papers considered simple transactions such as buying and selling artworks on auctions. The financial attractiveness of indirect investments in art through art funds is still a fruitful field of research. There are also art related derivatives that have already attracted attention of some scholars. Examples include an article by Kraeussl and Wiehenkamp (2012) who studied the implications of a call option on art index that would allow investors to hedge their exposure to art market.
5) Theoretical Context
A large number of papers that study art as an investment possesses similar characteristics. For instance, majority of academics use art indices either in the form of readily available ones or constructed by themselves. Some other similarities in research tools and samples can also be seen in a number of studies. A comparison between art and other means of investments often includes stocks, bonds as well as their sub-categories such as small-cap or large-cap stocks and government or corporate bonds. In addition, many studies on the topic focused not on art as a whole (that would be difficult and unreasonable to do), but on paintings, which represented around 80 percent of total auction turnover (Vosilov 2015). Nevertheless, common features of many papers do not preclude them from presenting a variety of interesting findings.
One of the most cited paper on the topic written by Baumol (1986) demonstrates that investing in paintings gave almost 2% less returns than investing in government securities. The real expected returns would be even lower as the research did take into account some related costs such as maintenance costs and sales commissions. Moreover, author concluded that investing in paintings has a significant risk. Frey and Pommerehne (1989) found similar results in their study and showed that investing in paintings is riskier but less profitable than investing in financial assets. A more recent paper by Worthington & Higgs (2003) considers different paintings markets such as Old Masters, Contemporary European, Impressionists, among others and presents similar evidence on lower returns but higher risks of investment. The authors assume though that it might still be possible to use some paintings markets for diversification purposes.
Some authors, rather than primarily investigating whether investing in art is better than investing in other assets, have also focused on using art together with alternatives in order to diversify an investment portfolio. Goetzmann (1993) states that due to strong correlation between demand for art and equity markets performance, art does not serve as an appropriate hedge against equity market fluctuations. The author also, unlike many other scholars, found that art as an investment yields to relatively high returns. However, these returns are justified by higher risks and after considering those risks, do not appear attractive anymore. An evidence showing paintings as poor diversification vehicle was also obtained by Stein (1977) who did not see support for a popular belief that art is less susceptible to recessions. The author obtained more neutral results on risk-return figures of paintings showing that they are no more and no less lucrative than other investment alternatives. Contrary to the evidence above, some academics have found the usefulness of investing in art for diversification purposes. Campbell (2008) observed low correlation between art and other assets and thus an opportunity for diversification even when taking into account transaction costs. Mei and Moses (2002) state that artworks may be an important component of a diversified portfolio due to their low correlation with other asset classes. Similarly, Kraeussl (2010) suggests using art to diversify a portfolio, but warns on its high volatility and poor ability to hedge against stock markets.
An empirical evidence showing the attractiveness of art as an investment asset is less common but is worth considering. Buelens and Ginsburgh (1993) used Baumol’s (1986) paper as a starting point and found that his conclusions about low profitability of paintings were too pessimistic due to higher weight of British paintings, which distorted the results, and the atypical artwork prices from 1914 to 1950. Authors argue that the low return of paintings over the period of 300 years still allows for 20 to 40 year periods of higher returns for some paintings markets. They also state that paintings might be a good opportunity for investment as tastes change slowly, but the returns will highly depend on factors such as period, artistic school and movement, etc. Tucker (1995) presents an even more positive evidence showing that art had the second highest return and the second lowest risk among the selection of seven asset classes. The findings suggested that artworks should be included in an optimal investment portfolio and should play a significant role in it.
Most of the authors who have studied art as means of investment have used either repeat-sales regression (RSR) or hedonic regression in their researches. In the repeat-sales regression used by a number of authors (e.g. Pesando 1993; Goetzmann 1993; Mei and Moses 2002) only those artworks that have been sold at least two times are taken into account. The benefit of this approach is that it controls the quality factor of works since the same items are sold (Goetzmann 1993). Alternative approach used by a number of academics such as Renneborg and Spaenjers (2009), Kraeussl (2010) and Frey and Pommerehne (1989) is hedonic regression. This method uses characteristics of items (e.g. artistic movement, artist’s name or subject matter) to obtain input values. The benefits of using hedonic regression approach include having larger samples by considering all sales and avoiding the need to use artworks of the same quality in order to make comparisons (Bialynicka-Birula, 2012) as well as giving more precise results (Chanel et al. 1996).
Besides various findings and opinions existing the topic of art as an investment and making it difficult to give a single answer on the research question, the shortcoming and limitations of many studies make the task even more complicated and require additional consideration. The limitations of some papers are easier to spot and avoid in future studies. For example, Baumol (1986) did not consider transaction costs in his study and the author’s sample did not go beyond year 1961. Similarly, Stein’s (1977) research does not cover the period after 1960s. In addition, both papers as well as some other articles on this topic were either limited to data from Anglo-Saxon markets or put too much weight on it. These shortcomings are overcome by Frey and Pommerehne (1989) by including more countries, considering transaction costs and covering extended a period or research until 1987. Some other limitations are more difficult to eliminate as they are inherent to research methods and design of papers. The repeat-sales regression used by many scholars is subject to sample selection bias, since the approach considers only artworks that were sold at least twice (Goetzmann 1993). For this reason, a survivorship bias also takes place as the limited sample only includes works the demand for which was high enough to result in at least two sales. Moreover, a so-called “backward-filled data” bias does exist in some articles (e.g. Tucker et. al. 1995) as prices of artworks taken from historical sales of prominent auction houses such as Sotheby’s and Christie’s might gravitate to the higher end of market. Other major drawbacks of using auction results for making conclusions about the art market are the infrequency of sales of individual artworks (Pesando 1993) and the fact that auction sales account for only around 25 percent of the transactions on the market (Sagot- Duvauroux 2003).
References:
1) Baumol, W. (1986) “Unnatural value: or art investment as floating crap game”,
American Economic Review, 76, 10-14.
2) Bialynicka-Birula J. (2012) “Investment in art: Specificity, Risks and Rates of Return”, Cracow University of Economics. 10-20
3) Blanding, M. (2017), ‘Why Global Diversification Is Still A Safe Bet For Your Investment Portfolio’, Forbes, (13 Jun), available:
https://www.forbes.com/sites/hbsworkingknowledge/2017/06/13/why-global-diversification-is-still-a-safe-bet-for-your-investment-portfolio/#256a49c960a1 [ accessed 14 February 2018]
4) Buelens, N., Ginsburgh, V. (1993) “Revisiting Baumol’s Art as Floating Crap Game”, European Economic Review, 37, 1351-1371.
5) Campbell, R. (2008) “Art as a financial investment”, Journal of Alternative Investments, (10), 64–81
6) Chanel, O., Gerard-Varet, L. and Ginsburgh, V. (1996) “The Relevance of Hedonic Price Indices”, Journal of Cultural Economics, 20, 1-24.
7) Goetzmann, W. (1993) “Accounting for Taste: Art and the Financial Markets over Three
Centuries”, American Economic Review, 83 (5), 1370-1376.
8) Frey, B. and Pommerehne, W. (1989) “Art Investment: An Empirical Inquiry”, Southern Economic Journal, 396-409.
9) Kraeussl, R. and Lee, J., (2010) “Art as an investment: The top 500 artists”, VU University Amsterdam, 4.
10) Kraeussl, R. and Wiehenkamp, C. (2012) “A call on art investments”, Review of Derivatives Research, 15(1), 1-23.
11) Jinping, M. and Moses, M. (2002) “Art as an Investment and the Underperformance of
Masterpieces”, American Economic Review, 92(5), 1656-68
12) Pesando, J. (1993) “Art as an Investment: The Market for Modern Prints”, American Economic Review, 83(5), 1075-89
13) Renneboog, L. and Spaenjers, C. (2013) “Buying beauty: On prices and returns in the art market”, Management Science, 59(1), 36-53.
14) Sagot-Duvauroux, D. (2011) “Art Prices.” In A Handbook of Cultural Economics, 2nd ed., R. Towse, ed. (p. 43–48). Northampton, MA: Edward Elgar.
15) Stein, John P. (1977) “The Monetary Appreciation of Paintings”, Journal of Political Economy, 1021-1035
16) Tucker, M., Hlawischka, W. and Pierne, J. (1995) “Art as an Investment: A Portfolio Allocation Analysis”, Managerial Finance, 21 (6), 16-24
17) Vosilov, R. (2015) “Essays on art markets: Insight from the international sculpture auction market”, Umea: Umea School of Business and Economics
18) Worthington, A. and Higgs, H. (2003) “Art as an Investment: Short and Long-Term Co-movements in Major Painting Markets”, Empirical Economics, 28, 649-68
