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Abstract
Executive Summary. This study evaluates the relative portfolio performance of the twenty largest MSAs by population through the application of modern portfolio theory (MPT) to economic base analysis. Each MSA is treated as a single portfolio comprised of the local industries and government services. Using employment and wage data covering the latest complete business cycle (peak July 81 to July 90 peak), portfolio risk, portfolio return and a relative risk estimate (“metro beta”) were calculated for each MSA. Covariances of employment changes between industries and governmental sectors were computed to determine the “portfolio risk”. Correlations of changes in aggregate employment between the MSAs were also computed in order to examine geographical diversification. In addition, the mean-variance efficiency of several naive portfolios was examined and the portfolios ranked.
Findings from this study indicate that economic base diversification by industry and government services at the MSA level yield diversification benefits for portfolios. Moreover, geographical diversification, based on correlations between MSAs, yields portfolio benefits that are superior to the naive approaches that were tested. This study provides institutional real estate investors with an another technique for improving the performance of their real estate portfolios.