Managing risk in the property market
The property sector needs to change the way it measures risk, with the Covid-19 pandemic showing the limitations of the current approach, according to BCU Professor of Real Estate David Higgins.
In an article for The Property Chronicle, he said that companies had traditionally modelled likely risks and returns on the basis of the standard mathematical tools of the mean and the standard deviation – in simple terms, the average figure and its likely variation. These are the tools used by many investors to compare performance across different assets and assess the likely risks and returns.
However, such models tend to exclude outlying values, and as coronavirus has shown, extreme outlying events still have the potential to significantly disrupt business.
David argued that in future other mathematical models such as Power Law – which balance intensity and frequency and are often used in scientific fields where extreme events need to be accounted for, such as the prediction of earthquakes – may be increasingly used by investors in the property sector.
David said: “As the real estate industry looks to learn from the fallout of Covid-19, one issue which should be at the top of the list is to recognise the glaring mathematical limitations in the traditional performance measurement models.
“Engineering a solution is important; as with high value thresholds and illiquidity, investment decisions cannot be easily changed when we experience an extreme risk event.”
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