Asymmetric Risk Measures and Real Estate Returns
Department of Industry Studies, Florida Atlantic University, 777 Glades Road, Boca Raton, FL 33431, USA
Rational investors distinguish between extremely high and extremely low returns. The measures of investment
risk should reflect such asymmetric risk perception. This study presents six asymmetric risk metrics and
empirically tests their abilities in explaining the cross-sectional variations of real estate returns. It finds strong
evidence that systematic downside risk is associated with a risk premium, and skewness provides significant
explanatory power to the variation of cross-sectional property returns. On the other hand, co-skewness does not
explain real estate returns well and is not a good systematic risk measure.
Key Words: asymmetric risk, real estate returns, portfolio management, skewness
The application of Modern Portfolio Theory (MPT) to real estate portfolio management
is often questioned for its two underlying assumptions: (1) asset returns are normally
distributed and, (2) investors view extremely high and extremely low returns as equally
undesirable. While the first assumption has stimulated much academic debate and
empirical study, the second assumption appears simply counter-intuitive. Rational
investors certainly prefer extremely high returns to extremely low returns. As Mao
(1970) reported, most investors perceive risk as only the chance of earning less than
certain target rate of return. The potential of earning better-than-expected returns, on the
other hand, is viewed as favorable upside potential. Such an asymmetric view toward risk
implies that asset returns need not to be normally distributed. In fact, other things being
equal, investors will prefer asset distributions with smaller left tail (negative skewness).
The relevant risk measure, therefore, should capture only the downside risk and/or the
skewness of asset return distributions. In the context of portfolio management, this means
that the inclusion of an asset depends on whether it reduces the downside risk or
increases the negative skewness of a portfolio. Standard deviation becomes irrelevant in
such an asymmetric world.
There is a stream of research in the finance literature that seeks alternative risk
metrics and portfolio models beyond the traditional mean-variance framework. One of
the most studied asymmetric risk measures is perhaps the so-called semivariance.
Markowitz (1959) was among the first to suggest semivariance as an alternative risk
measure to standard deviation. In a broader context, semivariance is known as the second
order Lower Partial Moment (LPM) of an asset return distribution. Hogan and Warren
The Journal of Real Estate Finance and Economics, 30:1, 89–102, 2005
2005 Springer Science + Business Media, Inc. Manufactured in The Netherlands.