The names Renoir, Manet, Monet, and Degas conjure up images of some of the world’s favorite and most widely recognized works of French Impressionist art. But as an investment, the market for these works is often viewed as intractable and risky. Is it possible to use the tools of finance to understand the investment quality of fine art?  Professor Rex Thompson of SMU Cox and Clare McAndrew of Trinity College, Dublin, attempt to quantify the investment risk of fine art and determine its collateral value in a forthcoming Journal of Banking and Finance paper.

Making a Market Modern
Thompson indicates that the art market operates at a somewhat primitive level compared to other developed asset classes such as the contemporary stock market. He likens it to 150 years ago, when paper stock certificates were traded under oak trees on Wall Street. Traders wondered who would succeed and who would fail among the mainly family-run businesses. The art market is traded with the same intuitive but grounded type of “guesstimates.” Over time markets mature, capital flows in, and markets stabilize—something that has not yet happened in the art market.

In the analysis, Thompson utilizes the sophisticated modeling techniques of finance, routinely used and applied to other capital markets, as a way to quantify the risk of art as an asset class. While art investors may be good at identifying good art and appraisers are pricing for the average relatively well, statistical analysis and issues go under the radar. From 16 years of data of 4,280 auctions from 130 international auction houses, French Impressionist paintings reveal the possibilities of the art market. The scholarly canon of Impressionist painters were chosen as they represent the most well-informed and liquid genre in the art market. Other genres such as Post-Impressionist, Modern, and Contemporary art markets may reveal other possibilities for a later analysis.

The findings show that the art market, in this case, holds promise as a viable investment. Thompson poses the question: “What do banks need to know about art for collateral purposes? Data about sale prices and estimates exist. Our findings reveal that while art appears more risky than other assets, it is really not a total gamble.” He believes that if banks would lend either for the purchase of art works or provide investors with carry trade financing for inventory, the liquidity gained in the market would smooth volatility and bring more players to the market.

Reflections of Culture
Niches have arisen across various financial groups to further the art market’s development.  A few firms have attempted art mutual funds that buy and hold art as their underlying asset. In some cases, high net-worth clientele receive financial services related to art by the largest of banks—JPMorgan Chase, Citigroup, and Bank of America. The recently announced Artist Pension Trust Beijing is a first of its kind in Asia and follows similar funds launched in New York, Los Angeles, and London, with plans to open additional trusts in Mumbai and Bangkok. The trusts are run by a New York-based firm, formed by art-appreciating investors seeking to develop financial service products for the art world.

With Wall Street’s desire to evaluate art’s investment potential, the authors’ research offers a solid methodology for moving toward banking and other financial applications.  Thompson mentions that based on the analysis, lending 30 percent to 40 percent of the lower estimate for an appraised work of art might not pose a significant risk. In developing the analytics for this research, which brings the art market further into mainstream finance, the authors included buy-ins as a part of the framework. Buy-ins, when a work does not sell for the lower estimate but is bought by the auction house, have been missing from most other forms of art market analysis. But Thompson and McAndrew prove they are a necessary ingredient for an accurate valuation of art as collateral.

“Art is maybe the most fundamental expression of a culture’s identity,” Thompson concludes. “It represents a culture’s ability to do more than just sustain itself. The fact that we make more money than we need to survive, and can use it for expression, somehow completes the full circle.” The art market will continue to develop and mature if affluent individuals’ investments are successfully channeled and managed.

“The Collateral Value of Fine Art” by Rex Thompson and Clare Andrew is forthcoming in Journal of Banking and Finance.

Summary by Jennifer Warren