Skip to content

FRM Part II · FRM Exam Part II · Illiquid Assets

A pension fund holds a large allocation to private real estate partnerships. The appraisal-based returns show a standard deviation of 6% annually, while the fund's analyst believes true economic volatility is much higher. Which feature of illiquid asset return reporting best explains why the reported volatility is understated?

Appraisal smoothing is the reason. Because appraised values adjust gradually to new information, reported returns show positive serial correlation, which dampens measured standard deviation and understates true economic risk of illiquid assets such as private real estate.

  1. AAppraisal smoothing, which induces positive serial correlation in reported returnsCorrect
  2. BMark-to-market pricing from exchange trading, which dampens short-term fluctuations
  3. CSurvivorship bias that raises the reported standard deviation
  4. DDaily NAV publication, which averages out noise across investors

Explanation

Appraisals update slowly and rely on past comparable values, so reported returns are smoothed and positively autocorrelated. This understates volatility and correlation with public markets. The other options either describe liquid-market pricing or do not reduce measured volatility.

Did you get it right without looking?

One question tells you little. A timed set on Illiquid Assets shows your real accuracy, how long you take and where you lose marks.

Practise Illiquid AssetsFree diagnostic mock

More Illiquid Assets questions