Following in the wake of my friend Peter Benda's research of various housing markets around the country, I decided to download some data from the government (OFHEO) and do some simple exploration myself. As you may recall, I've been contemplative this year of the lack of connection between risk and return as shown in the book Finding Alpha. Well, I thought it may be interesting to follow that train of thought into the real estate sector where I happen to have a personal interest due to my line of work.
To that end, I took a look at whether or not there is a statistical connection between risk (as measured by volatility) and return (price appreciation) as it pertains to housing prices within the top-25 metro areas in the US. As you can see in the scatter chart above, where each dot represents a different city's position on the risk/return plane, there is no apparent connection (click each chart twice to view clearly).
I think the take away is that investors should try to minimize risk as much as possible. If the future looks anything like the past, this strategy ought to result in average returns with below-average volatility. Of course, the next logical question is how one should minimize risk. One possibility would be to allocate an equal weighting of one's investment portfolio to each market, which I think should be the null hypothesis. Another possibility would be to allocate market weights according to what would have minimized volatility within the past say 10 years, but this approach assumes that the standard deviations and correlations of and between market returns will persist into the future. Next week we'll see if this is the case.
Quote for the Week: "My third maxim was to endeavor always to conquer myself rather than fortune, and to change my desires rather than the order of the world, and in general to habituate myself in the belief that save our thoughts there is nothing completely in our power, and so to recognize, in respect of the things which are external to us, that when we have done our best, whatever is still lacking to us is, so far as we are concerned, absolutely impossible of achievement. This, it seemed to me, is sufficient to prevent me from desiring for the future anything which I knew myself incapable of having, and so to render me content. For since our will does not of itself lead us to desire anything save what our understanding exhibits as being in some fashion possible of attainment, it is evident that if we consider external goods as being all alike beyond our power, we shall no more regret the absence of goods that seem due to our station, should we through no fault of our own be deprived of them, than we do in not possessing the kingdom of China or Mexico. Making thus, so to speak, a virtue of necessity, we shall no more desire health when ill, or freedom when in prison, than we now do bodies made of a matter as little corruptible as diamonds, or to have wings to fly like birds. There is, however, I confess, need of a prolonged discipline, and of meditation frequently renewed, if we are to hold firmly to this attitude in all circumstances..." - Rene Descartes (1596-1650)
