FRM Part II · FRM Exam Part II · Illiquid Assets

A pension fund's private real estate fund reports quarterly returns that show very low volatility and strong positive first-order autocorrelation, while listed REITs holding similar properties show much higher volatility. Which interpretation is most consistent with the standard analysis of illiquid asset returns?

Reported returns are likely smoothed because appraisal-based valuations lag market prices. Smoothing creates positive autocorrelation and understates volatility, so the low measured risk does not reflect the true economic risk of the underlying illiquid assets.

1. AReported returns are likely smoothed because appraisal-based valuations lag market prices, so measured volatility understates true economic riskCorrect
2. BThe low volatility shows that the underlying properties are genuinely less risky than listed REITs
3. CPositive autocorrelation indicates that the fund has strong skill in timing the property market
4. DThe difference arises because private funds hold no leverage while REITs are always highly leveraged