I got some inquiry about a question from after-chapter “Alternative Investment Portfolio Management”, CFAI Book:
Chavez’s perference for the unsmoothed version of NCREIF Index instead of the smoothed version is most likely because the:
A) Smoothed version includes the effect of leverage on returns;
B) Smoothed version is based on actual unreliable market values;
C) Bias arising from infrequent appraisals is corrected in the unsmoothed version
Why answer is C? Isn’t that the infrequent appraisals being correted in smoothed version and hence bias arises? From schewser’s book, it states that the unsmoothed data raises the standard deviation and reduces sharp ratio of the real estate, making the real estate less attractive. Thanks.
nopes. less frequent appraisals of property values tend to smooth the index values i.e mitigate the effect of outliers hence the word “smooth”
when outlier effect is mitigated, standard deviation will be naturally lower than otherwise and this gives a false impression of lower risk… using index data with unsmoothed version increases standard deviation to incorporate that effect of outliers to some extent so there is higher risk, which is a more conservative and reliable approach