Academic journal article Journal of Real Estate Portfolio Management

Asset Meltdown-Fact or Fiction?

Academic journal article Journal of Real Estate Portfolio Management

Asset Meltdown-Fact or Fiction?

Article excerpt

Executive Summary. This paper analyzes the relation between demographic structure and real asset returns on Treasury bills, bonds, and stocks for the G7 countries (United States, Canada, Japan, Italy, France, the United Kingdom, and Germany). A macroeconomic multifactor model is used to examine a variety of different demographic factors from 1951 to 2002. There was no robust relationship found between shocks in demographic variables and asset returns in the framework of these models, which suggests that asset meltdown is rather fiction than fact.

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In recent decades, severe demographic changes could be observed in industrialized countries around the world. Declining birth rates were accompanied by increasing life expectancies. Due to these trends, unfunded pay-as-you-go pension schemes, which are traditionally a key determinant of retirement security, face increasing financial challenges, since the benefits of the retirees are primarily funded by contributions from the labor force. Without tremendous changes, the contributors-beneficiaries ratio will decrease, leading to a cash shortage in these types of pension systems. Exhibit 1 shows the development of this ratio from 1950 to 2050 within the G7 countries (United States, Canada, Japan, Italy, France, the United Kingdom, and Germany). It has been assumed that individuals aged 20 to 64 were contributors; the ones aged at least 65 beneficiaries. The contributors-beneficiaries ratio declined from 6.7:1 in 1950 to 3.9:1 in 2004. According to projections, a further decline to 2.1:1 in 2050 is expected.

In order to replace unfunded public pension benefits and move towards a more prefunded program, many countries have permitted workers to invest some of their payroll into personal retirement accounts or pension funds of the defined contribution variety. Within these programs individuals accumulate assets (e.g., stocks, bonds, or real estate) during their working life, and at retirement, these assets must be converted into a reasonable stream of retirement income. Nevertheless, it is argued that these systems can also be influenced by demographic changes. Large generations retiring at once might want to withdraw substantial amounts from capital and property markets, which could result in a significant decline of asset prices, a phenomenon referred to as asset meltdown. If such relationship between demographic structure and asset returns exists, it is questionable whether funded pension systems could help solve the problem of financing pension systems for aging populations.

This study examines whether or not there is a relationship between the returns of various assets categories and demographic factors for the G7 countries. Besides stocks and fixed income, the investigation also includes investments in real estate. Since real estate is not only an investment, but also a consumption good, real estate should be more heavily affected by demographic changes than other asset classes.

This paper contributes to the literature in several ways. First, while existing studies focus on national capital markets, this study takes the impact of international capital flows into account. Second, existing work is extended by controlling for changes in macroeconomic factors. Finally, this is the first paper that analyzes the impact of demographics on international real estate prices.

The outline of the paper is as follows: There is a review of the relevant literature, followed by a description of demographic, as well as the macroeconomic factors. The model is described next. The sections that follow introduce the data, describe the tests of assumptions, and discuss the empirical results. The paper closes with a brief summary.

Literature Review

The asset meltdown phenomenon has been addressed in the literature from both an empirical and a theoretical perspective. The review of the literature follows this classification. …

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