Appraisal smoothing

The understatement of measured volatility and correlation that arises when an asset is valued periodically by estimate, each estimate anchored partly to the previous one, rather than being traded continuously.

Example

A true series with a 14.27% standard deviation recorded at 5.77% - 40.4% of the true figure - with the worst year softened from -17.00% to -4.12%.

Important

It crushes measured risk far harder than measured correlation, so the misleading number in a property comparison is usually the volatility rather than the correlation. Any statistic from an annually appraised index is a lower bound, not an estimate.

Related terms

• Appraisal — A professional estimate of what a property would sell for, reconciling comparable sales with a capitalisation of the income and adjusting for what the comparables did not match.
• Correlation — A measure from +1 to -1 of how closely two assets have moved together over a chosen period. +1 is lockstep, 0 is no relationship, -1 is exactly opposite.
• Mark to market — Valuing an asset at what it would sell for right now, rather than at what you originally paid for it.

Lessons that explain it

• A price is a guess between two auction estimates until a hammer actually falls — There is no continuous market here - only comparable sales, an appraiser's estimate, and an auction reserve that can fail to be met. The gap between what an item is 'worth' and what it actually sells for can be wide, and it is measured only at the moment of an actual transaction. (12 min)
• A loan's rate is a stack: base rate, expected loss, illiquidity and fees — Private loans are priced by building up from a risk-free rate, adding compensation for defaults, for being unable to sell, and for the intermediary. Values between lending and repayment are mostly estimates. (11 min)
• The entry multiple is set by auctions, and the fund's value by its own appraisals — Buyouts are priced as a multiple of earnings in competitive sales, and between purchase and exit the fund's value rests on appraisals that move far more smoothly than markets. (11 min)
• A leveraged cousin of your stock portfolio, not a separate world — Buyout exposure behaves more like leveraged small and mid-sized company equity than its smooth reports suggest, so it belongs in the equity bucket and only in modest size. (8 min)
• A real asset with a flattering picture of itself — Property earns its place through contracted income from a physical thing, driven by different forces from a share. But its low measured volatility is partly an artifact of being appraised rather than traded, and that artifact has a size you can compute. (9 min)

All 578 terms in the Investing glossary