Investing in fine art versus the stock market.Investments

Kristin Lovejoy

English

Research Papers in Economics

illustrations by marc rosenthal Regional Review Q2 2002 1
Smart Art
there’s more to the art world than pretty
pictures. Many prospective buyers consider
art an investment. When art prices escalated
in the late 1980s, the odds of a favorable return
seemed good. “Yo Pi-
casso,” priced at $5.8
million in 1981, sold
for $47.8 million in
1989; the 1990 $82.5
million sale of Van
Gogh’s “Portrait of
Dr. Gachet” made
history as the highest
price ever paid at auc-
tion. Though this was
a high-water mark,
savvy collectors Vic-
tor and Sally Ganz
netted $183.8 million in revenue in one 1997
auction, which was $50 million more than the
couple would have earned if they’d invested in
small company stocks, and $137 million more
than in large company stocks, estimated Uni-
versity of Chicago professor William Landes. 
What are the chances for the rest of us? Be-
cause artworks are usually one-of-a-kind
pieces and change hands so infrequently, av-
erage returns are difficult to estimate and vary
greatly, depending on the body of works and
the time periods considered. On the one hand,
using an index of repeat sale prices of paint-
ings on auction at Christie’s and Sotheby’s,
Stern School of Business professors Jiangping
Mei and Michael Moses at New York Uni-
versity found promising results. Art generat-
ed an average annual return of 8.2 percent
over the last 50 years, comparable to the 8.9
percent return on S&P 500 stocks, and was
only somewhat more volatile. But in a similar
study of Picasso prints, where comparable du-
plicates enabled a large sample size, Univer-
sity of Toronto professor James Pesando
found only a 1.5 percent annual return over the
last 20 years, with as much volatility. Fur-
thermore, these estimates may be
high because of large transaction
costs—auction houses take up to 20
percent of the sale price—and be-
cause of a survivor bias—already
successful works, like those includ-
ed in these in-
dexes, may poorly repre-
sent the broader pool of
not-yet-famous art.
Whether or not art in-
vestments can measure up
on their own, evidence
that they are not very cor-
related with traditional fi-
nancial assets suggests
they might be useful for
portfolio diversification.
With this in mind, the
British Rail Pension Fund
included a relatively successful portfolio of art
and antiques between 1977 and 1996. But in
Pesando’s study, even when diversification is
taken into account, the return on art is not at-
tractive enough to significantly improve port-
folio performance. A better strategy may be for
buyers to take advantage of their own exper-
tise in lesser-known art markets. For example,
Pesando himself favors 18th-century Ameri-
can furniture; he might find a deal on a valu-
able chair at a flea market in Vermont, but
there’s little chance of finding a Picasso. 
Of course, art also provides consumption
value. Many buyers are willing to spend more
on art than monetary returns alone justify be-
cause of the pleasure of viewing the object. In-
deed, the vast majority of the Ganzes’ 1,000-
plus-piece collection remains on their estate.
Perhaps the safest bet is to select art invest-
ments that buyers actually enjoy—art for art’s
sake after all. —Kristin Lovejoy
Test driving the Internet
Buying a car ranks as one of the biggest purchases consumers make. They invest
great amounts of time in researching models and options, not to mention going
from dealer to dealer to test-drive and haggle for a reasonable price.
Can the Internet make this process
any easier? Numerous websites offer
free information on the dealer cost of
new cars, trade-in value of used ones,
and even dealership inventory. Others,
such as Autobytel.com, are third-party
“infomediaries.” Aside from providing
vital statistics on vehicles, Autobytel
connects consumers with car dealers.
Potential buyers submit a request for a
price quote on a specific car—along
with their name, zip code, and contact
observations
0
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’77 ’01 ’80 ’83 ’86 ’89 ’92 ’95 ’98
Painting the returns
Index 1977=1
S&P 500
PAINTINGS
PICASSO
PRINTS
sources: Paintings Index from Mei and Moses, “Art as an
Investment and the Underperformance of Masterpieces,” American
Economic Review, forthcoming; Picasso Prints Index from Pesando
and Shun, “The Returns to Picasso’s Prints and to Traditional
Financial Assets, 1977 to 1996,” Journal of Cultural Economics,
1999; and S&P 500 from the Wall Street Journal.
(continued on next page)2 Regional Review Q2 2002
Observations
continued from previous page
information—which is forwarded to the dealer
assigned to the area.
And customers may be reaping the benefits.
Economists Florian Zettelmeyer, Fiona Scott Morton,
and Jorge Silva-Risso found that buyers who used
Autobytel saved an average of 1.2 percent compared
to those who purchased a car through conventional
means. The researchers estimate that the savings
are even greater—slightly above 2 percent—if the
customers who opted for the Internet are those that
pay higher prices at conventional dealers (such as
those who are poor bargainers).
The researchers found several reasons for the
lower prices. First, dealers have a contract with
Autobytel that provides incentives to offer lower
prices. Dealers are required to have a salesperson
who only handles Internet requests and is paid
based on sales volume, rather than on the profit
extracted from negotiating with each customer. 
In addition, some customers used Autobytel but
made their purchase at a dealer other than the one
they were referred to—and they also received lower
prices. This suggests that Internet research makes
online consumers more educated about their pur-
chase and, thus, better negotiators. The low cost of
searching on the Internet could also expand buyers’
options and make it easier to explore distant dealer-
ships and more types of cars in search of a better
deal. Or, perhaps a specific price quote from an
Autobytel-associated dealer gives them leverage to
obtain a better price elsewhere.
Alas, the emergence of the Internet has not made
haggling a thing of the past. A recent online buyer
found that instead of being given a direct quote on
a new car, dealerships invited him to come in and
discuss the issue with them. According to JD Power
and Associates, 14 percent of dealers associated
with Autobytel will quote a discounted price by email
or phone only if the customer insists, and 2 percent
won’t give quotes at all until the customer comes to
the dealership.
—Jennifer Duval
Tobacco manufacturers are
now compensating states for
smoking-related costs. How
will this affect the economy?
By David M. Cutler, Jonathan Gruber, Raymond S.
Hartman, Joseph P. Newhouse, and Meredith B. Rosenthal
smoking costs the Massachusetts Medicaid program money.
The more people smoke, argues the Attorney General’s office, the more
the state spends on Medicaid to pay for smoking-related illnesses. To
recoup these costs, the Attorneys General of Massachusetts and 45
other states took the tobacco manufacturers to court. In November
1998, cigarette companies agreed to pay out $104.7 billion in dam-
ages through the year 2025—the largest sum of money paid in any civ-
il litigation in American history. The master settlement agreement
(MSA) requires tobacco manufacturers to pay reparations for states’
Medicaid expenses, totaling up to $9 billion per year. They must also
sponsor several billion dollars’ worth of anti-smoking advertising and
education over the next ten years and must restrict their advertising
in public places such as outdoor arenas and public transit. The cost
will be covered by a 45 cent per pack price increase on cigarettes, which
was put into effect immediately following the settlement.
What are the economic impacts of the settlement for Massachusetts?
The most obvious is an increase in state revenues; the MSA will net
the Commonwealth an estimated $4.2 billion in revenues over the next
quarter-century, roughly 2 percent of total tax receipts. But, while this
will be an important source of funds to cover the state’s smoking-re-
lated expenses, it doesn’t lead to a net gain for society since it simply
represents a transfer of resources from one group (future smokers) to
another (all the citizens of the state). The benefits to society depend
on how much smoking rates decline due to the agreement, and on as-
sumptions about why people start smoking in the first place.
THE SOCIAL PAYOFF OF IMPROVED HEALTH
How big a social benefit we reap is determined, in part, by how the
settlement influences smoking behavior. First, the 45 cent per pack
price increase raised the cost of cigarettes by about 15 percent per pack.
This is likely to reduce tobacco consumption since as the price of cig-
arettes increases, smokers cut back and nonsmokers are less likely to
start smoking. In fact, recent research shows that the 15 percent price
increase should lead to about a 5 percent decline in smoking partici-
pation among adults. Estimates of the impact of the price increase on
youth smoking are somewhat more difficult to quantify and range from
zero to about 6 percent. The anti-smoking advertising campaign
should also cut smoking rates; other experiments with this type of ad-
vertising have yielded a 5 percent or greater reduction in smoking. The
perspective
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Observations: smart art

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Observations: smart art

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