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FRM Part II · FRM Exam Part II · Illiquid Assets

A pension fund's private real estate fund reports quarterly returns that show much lower volatility and a higher first-order autocorrelation than a listed REIT index tracking similar properties. Which is the most likely explanation for the reported series?

Appraisal-based valuations that rely partly on lagged values smooth reported returns. This lowers measured volatility and creates positive autocorrelation, so the series understates true economic risk compared with a market-priced REIT index.

  1. AAppraisal-based valuations are partly based on lagged values, smoothing the reported returnsCorrect
  2. BReal estate cash flows are negatively correlated across quarters
  3. CReported returns are marked to market daily and are therefore more volatile
  4. DThe fund uses leverage that is rebalanced every quarter

Explanation

Appraisal-based or stale valuations average past and current values, which dampens reported volatility and induces positive autocorrelation. Daily marking to market would produce the opposite effect, and quarterly leverage rebalancing does not explain lower volatility.

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