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October 9, 2007

Art bubbles

In Speculation in Art and There's No Speculative Bubble in the Art World, Felix Salmon over at Market Movers writes about the possibility (or lack there of) a speculative bubble in the art business. The sociology of the art world isn't something I know anything about, and I found them both and interesting and quick read.

How should one value a piece of art? A work's value should be the discounted sum of its stream of services (getting to look at it, take pride in owning it, decorating your house with it) and eventual resale price. . Estimating this discounted sum of its stream of services is tricky. Art is a luxury good, and as people get richer the we are willing to pay a greater percentage (of a greater pie) on art services.If that elasticity were known, then when changes in the growth rate of income for the rich were known (say proxied by the stock market) then that would influence the value of art services (with high comovement). In that case you'd see art prices swinging around with the stock market. That seems like a neat trick, because in a sense the stock market level is supposed to summarize those very same discounted expected value of future economic growth. Like in real estate, we probably don't see the true volatility in prices because markets dry up when prices fall. Of course, that comovement going to influence the resale value, and that's where the bubble happens.

To claim a bubble, you essentially are arguing that the discounted stream of services (forever) are are lower than the current price. If you believe that the stream of consumption is the same but nevertheless the resale price is going up then you'd pay a higher price for art than the the discounted sum of its stream of services suggests it is worth. What transforms beliefs about future price increases in the art market into a full blown bubble?

It is fairly well know what market attributes permit bubble formation. Separately, and more so if jointly, the following are contributory factors to bubble formation: inability to short-sell, high transaction costs, and inexpensive and readily available leverage. The art market has all three. One can get a non-recourse loan against art. Short-selling is essentially impossible due to the unique nature of art, although perhaps some more common works like prints or collectibles could be shorted with the right contract, and transaction costs are high. Ebay to the contrary, most fine art is sold in galleries or at auction houses with fees over 10%. That's comparable to the transaction costs on selling a house.

I have no idea if there is a bubble in the art world, but there could be.

Posted by OneEyedMan at October 9, 2007 7:29 AM

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