Stress Test For The Financial Optimization Models During The 2009 Recession

Abstract

The Sub-prime Mortgage credit crisis has led to a major downturn in virtually all financial sectors and consequently the real estate sector received the brunt of the 2008 – 2009 financial crisis. However, this downturn undoubtedly has provided an opportunity to test what investment strategy could have deflected the shocking force of this crisis and specifically what method could have minimized the risk of the most negatively affected investment -- Equity Real Estate Trust funds. Using ex-post data of EREITs, this research examines the implications and benefits of employing optimal portfolio allocation methods to different size EREIT portfolios during current financial crisis. This study compares the returns of optimally weighted EREIT portfolios to equally weighted EREIT portfolios, against the Dow Jones Equity REIT Index (DJEREIT Index). The results indicate that a properly rebalanced risk-adjusted model portfolio (RAMP) outperforms both an equally weighted portfolio of identical assets and the DJEREIT Index. In fact, the twelve-asset optimized portfolio yields a superior return of 12.7% when compared to a return of an equally weighted portfolio of identical EREITs, and the DJEREIT Index during the three-year time period examined.