Investment in art is part of what is called “alternative investment,” i.e., investment other than stocks, bonds or cash. Such investment has some typical characteristics: The current market value is difficult to evaluate; compared to financial assets such objects are more illiquid; the information needed before investing is substantial; and the cost of purchase and sale may be high.
The art market shares these characteristics. Almost half of all transactions have been judged to occur at auctions, the other half are handled by art dealers. Auction prices nevertheless dominate the market as they serve as guidelines to art dealers. While transaction costs on financial markets typically are below 1 percent of the price, in auctions the seller and buyer have to pay a commission between 10 percent and 25 percent of the hammer price. These costs are often disregarded when estimating returns on art investments. Dimson and Spaenjers are an exemption: When considering transaction costs at sale of 25 percent, the investments in expensive British stamps, as a sort of art investment, have to have a holding period of at least 4 years to reach a positive return after costs, compared to equity with < 3 month on average. In almost all studies on the art market, the estimated return has to be considered an upper bound prior to transaction costs. Transaction costs are, however, crucial when considering art investments. It is an open question whether the market forces exerted by web-auction houses such as artnet.com, artprice.com or eBay-Art can sustainably reduce transaction costs. Generally, these web auction houses offer better access for sellers and buyers to auctions as well as lower transaction costs. They range between 5 percent and 10 percent of the price fetched, depending on the level of prices and the amount of lots sold. In addition to transaction costs, buyers of art objects are confronted with special risks beyond price variability. The first set of risks refers to the art object itself. The buyer can never be certain whether the object acquired is an original or whether it is a copy or an outright forgery. This is not always a problem. In Asian art, as well as with orthodox icons, copying is commendable, as it expresses honoring the past. Nevertheless, in Western art primarily sold at auctions today, authenticity is an important feature. Similarly, attribution has a strong influence on prices of art. Whether a painting was made by the master himself, the circle, the school, or whether it is only in the style of a grand master is crucially important. Frey and Pommerehne report the story of the painting “Daniel in the Lion’s Den”. In 1882, the work was sold at Christie’s London for £1680. After the attribution of the painting was changed to Jakob Jordaens, it was sold in 1963 for only £500. Two years later, the New York Metropolitan Museum bought the painting for £178,600 after the work was attributed to Rubens again. Another specific feature of art objects is their quality. Over the centuries, many paintings have suffered and have been repainted. Such manipulations tend to reduce the prices paid. The risks just mentioned are substantial in the arts market but nearly absent in the financial market these days. In addition, the buyers of art run the risk that the object in their possession could be stolen or may be destroyed by fire, in wars and revolutions, or may be the target of terrorist attacks. To guard against at least some of these risks the art object may be insured but the premium to be paid is substantial and lies between 0.1 percent and 0.5 percent of the artwork’s value. The second set of risks of special importance in the art market refers to unforeseen public interventions. Governments may simply seize art objects claiming that they are part of “national heritage.” They may change the sales or property tax or change the property rights away from the owner towards the artist who created the art object. Governments may also impose new export restrictions. A third set of risks is shared with other investment but may affect the art market more strongly than financial markets. William Goetzmann, Luc Renneboog and Christophe Spaenjers present evidence that a 1 percent fall in income of the earners in the top 0.1 percent income distribution in the UK triggers a fall in art prices of almost 10 percent. A fourth set of risks refers to the unpredictable changes in tastes and fashions prevalent in the art world. Art markets are characterized by extreme heterogeneity. Perceptions play an even more important role than on financial markets, as they reflect purely personal preferences. A final set of risks is due to the important role behavioral anomalies are likely to play in the arts. There is certainly a stronger ownership bias than is the case with financial instruments: once a collector owns a piece of art, he or she establishes a special relationship to it and tends to be unwilling to sell it. Collectors also tend to buy art produced by domestic artists. This home bias seems to be larger than the equity home bias in financial markets. There might also be more pronounced herding behavior on the buyers’ side than on financial markets because, as William Baumol notes in his seminal article, art objects do not have any “natural” value, which could be used as a reference point for their valuation.