Modern Chinese paintings: an investment alternative?

• Author: Mok, Henry M.K.
• Position: Communications

1. Art Investment

   Research on art investment has been scarce and concentrated primarily on Western paintings. Gerald Reitlinger's |17~ three volumes of The Economics of Taste were the first major study on the investment of paintings. Volume I is about the rise and fall of prices on paintings for the period from 1760 to 1960, while Volumes II and III are about other art objects. Although this study is a qualitative survey of the rise and fall of picture prices, Reitlinger concluded that art prices behaved in a random fashion.

   Baumol |3~ argued on the basis of a priori considerations that in the market for visual arts, particularly the works of the late well-known artists, an equilibrium price level may not exist. Based on Reitlinger's data, Baumol also verified that art prices float aimlessly and behave randomly. The volatility of return is apt to be exaggerated by the art speculators who experience large gains or losses by holding works of art for only a short period. He estimated that on average, the purchase and subsequent resale of a painting brought an annual compound rate of return of 0.55 percent in real terms. This average return on paintings, however, was only about 1/6 of that of a government security.

   Frey and Pommerehne |12~, by adding new data from European markets to Reitlinger's data, extended the study period from 1635 to 1987 and selected only paintings with "auctionable quality" in their study. Net of all transaction costs and deflated by a price index, they found a 1.5 percent real monetary rate of return on paintings, which was lower than the rate of return on financial assets. Paintings may yield financial benefits, but to a large extent they provide a viewing service and a psychic reward |1; 12~. This low financial return on paintings may even be upwardly biased because of the cost of maintenance, restoration, insurance, and the inherent selection bias (i.e., in general, only successful art is repeatedly auctioned) |12~.(1)

   A study on the monetary appreciation of paintings was done by Stein |19~. His study was based on auction prices of paintings in the United States and Britain for the years 1946-68 and paintings by artists who died before 1946. He constructed annual auction price indices for the two countries and found that investment in paintings is neither more lucrative than other assets, nor are the values of paintings secure during times of economic recession. The investor's non-pecuniary return from viewing pleasure was 1.6 percent. Large non-systematic risk found in the return of paintings also suggested that collectors should diversify to other assets.

   Reilly |16~ examined the Sotheby's Indexes for the period of 1975-87 in terms of rates of return, measures of risk and the correlation among the series. The results indicated that no generalized conclusion could be drawn on the performance of art and antiques.(2) By employing the capital asset pricing model (CAPM), Bryan |4~ examined the investment and consumption characteristics of paintings for the period 1971-84.(3) He found that only 56 percent of the variation in the paintings' return is explained by CAPM under conditions of uncertainty. The paintings' rate of appreciation outpaced the rate of increase in the general price index over the study period but their performance had been volatile. In fact, paintings depreciated in value for the period 1980-81. The painting index, however, on average is not measurably more risky than a market portfolio containing stocks, bonds, and real estate. Recently, Ferris and Makhija |6~ estimated the inflation hedging ability of other collectible assets such as gold, diamonds, and Sotheby's artwork/antiques. Their evidence showed that it is not always appropriate to recommend these collectibles as inflation hedges, especially during periods of moderate price increases.

   To summarize, research on art investment are limited to Western paintings. Investing in Western paintings is generally not a lucrative investment vis-a-vis the return from other financial assets, such as stocks and bonds. The activities of art speculators also exaggerate the return volatility of paintings and a large non-systematic risk suggests collectors should diversify their wealth to other assets. Scholarly work on Oriental art investment is seriously lacking. By studying modern Chinese paintings as a financial investment in this paper, we hope to partially fill this gap and complement the findings on Western paintings.

   The Chinese art market has become active only recently with the most prominent international auctions being held in Hong Kong |13~. Prices in several sectors of the Chinese art market, including ceramics, jades, paintings and calligraphy have risen to record highs. Among these different sectors, the one that has captured wide media attention is the modern Chinese painting market |5; 15~.

   The market for modern Chinese paintings was quite thin a decade ago, during which paintings were bought mainly for collection and for aesthetic reward...