Real estate risk: heavy tail modelling using Excel
| DOI | https://doi.org/10.1108/JPIF-05-2014-0033 |
| Date | 06 July 2015 |
| Published date | 06 July 2015 |
| Pages | 393-407 |
| Author | Roger Brown,Beate Klingenberg |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
PRACTICE BRIEFING
Real estate risk: heavy tail
modelling using Excel
Roger Brown
University of San Diego, Alpine, California, USA, and
Beate Klingenberg
School of Management, Marist College, Poughkeepsie, New York, USA
Abstract
Purpose –The purpose of this paper is to present a practice briefing in the form of a user’s manual for
Excel-based simulation of real estate risk. Based on a generic discounted cash flow model, the
simulation incorporates the often ignored heavy tail behaviour of real estate investments, and
consolidates Jensen’s inequality. The briefing attempts to explain a model that permits the user to
decide whether to include extreme events in real estate risk modelling and how extreme these events
may be. Practitioners can generate a variety of modelling outcomes and then choose risk comfort zones
in which to contemplate a range of returns.
Design/methodology/approach –The paper provides an overview of the underlying mathematical
concepts and challenges, as well as on the perspectives on their application from the current academic
literature. It offers a step-by-step walk-through of the Excel model (the model being downloadable at:
www.mathestate.com).
Findings –Existing models for real estate risk modelling fall short with respect to realistic simulation
of the probability of extreme events due to challenges in the implementation of stable laws.
These former barriers to the implementation of stable laws have been overcome by providing a unique
combination of Excel-resident functionalities with a stable pseudo random number generator.
Research limitations/implications –Investment advisers no longer need expensive add-ins to
estimate risk. The presented Excel model is more robust than common approaches as it considers
distribution shapesthat are not otherwise easilyavailable. Theonly apparent limitationis that users need
to be familiar with the most basic functionality of Excel.
Practical implications –Practitioners are provided with an easy-to-use Excel model that does not
require further software add-ins. The model simulates real estate investment returns, based on a more
realistic inclusion of risk behaviour. It allows specifying how much extreme value behaviour
characterizes the volatility in future projections modelled to guide investment decisions.
Social implications –Risk is a cost to society. Many recent news events demonstrate the importance
of including extreme values in modelling. The paper attempts to contribute to more realistic risk
estimation in real estate investment.
Originality/value –This briefing introduces a real estate risk simulation model that includes using
stable laws, using Excel, a familiar and widely used platform. Such a model has not previously been
reported in the academic or practitioners’literature.
Keywords Heavy tails, Modelling risk, Spreadsheet models, Stable distributions, Cash flow model,
Real estate investments, Stable laws
Paper type Technical paper
Introduction
Real estate investment –as any other form of investment –represents the idea that the
investor forgoes immediate consumption, but instead provides funds in exchange for
future returns. This behaviour is motivated by the expectation that such future returns are Journal of Property Investment &
Finance
Vol. 33 No. 4, 2015
pp. 393-407
©Emerald Group Publis hing Limited
1463-578X
DOI 10.1108/JPIF-05-2014-0033
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
The authors would like to thank name removed for the confidentiality of the review process and
two anonymous reviewers for helpful suggestions. All errors remain solely those of the authors.
393
Heavy tail
modelling
using Excel
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