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FRM Part II · FRM Exam Part II · Illiquid Assets

A fund holds private real estate valued by quarterly appraisals. An analyst notes that its reported returns show strong positive first-order autocorrelation and a very low standard deviation compared with a listed REIT index tracking similar properties. Which conclusion is most appropriate?

Smoothed appraisal-based returns show positive autocorrelation and understate volatility and correlations with other assets. The low reported risk is a valuation artifact rather than evidence of lower economic risk, so the analyst should recognize that true volatility is higher than reported.

  1. AReported volatility likely understates true economic volatility, and correlations with other assets are biased downwardCorrect
  2. BReported volatility likely overstates true volatility because appraisals add noise
  3. CThe positive autocorrelation shows the fund has genuine momentum that can be exploited
  4. DThe low volatility proves the assets have lower economic risk than listed REITs

Explanation

Appraisal-based valuation smooths returns, producing positive autocorrelation, understated standard deviation and understated correlation with liquid markets. Overstated volatility is the opposite effect. Autocorrelation here is an artifact of valuation, not tradable momentum.

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