The Worth of Art: Financial Tools for the Art Markets 9780231554268

Citation preview

The Worth of Art

Columbia University Press Publishers Since 1893 New York Chichester, West Sussex cup.columbia.edu Copyright © 2023 Columbia University Press All rights reserved Library of Congress Cataloging-in-Publication Data Names: Cifuentes, Arturo, author. | Charlin, Ventura, author. Title: The worth of art : financial tools for the art market / Arturo Cifuentes and Ventura Charlin. Description: New York : Columbia University Press, [2023] | Includes index. Identifiers: LCCN 2022059817 | ISBN 9780231201780 (hardback) | ISBN 9780231554268 (ebook) Subjects: LCSH: Art—Valuation—Handbooks, manuals, etc. Classification: LCC N8675 .C54 2023 | DDC 338.4/77—dc23/eng/20230322 LC record available at https://lccn.loc.gov/2022059817 Printed in the United States of America Cover design: Noah Arlow Cover image: Frames: Shutterstock. Images: public domain.

To the City of New York, a place we call home, where finance and art come together.

Contents

pre face g l o ssary

ix xv

PART I . UN D E RSTAN D IN G TH E A RT MA R K ET S Introduction

3

1 Estimating Returns in the Art Market

12

2 Simple Comparisons to Uncover Interesting Trends 41 3 Price and Color in Paintings 67 4 Art Market Indices 106

vii

Contents

PART II. IN VE STM E N T ST R AT EG I ES 5 Portfolio Management Strategies 125 6 Art-Secured Lending 154 7 Auction Guarantees

173

8 The Market for Collectibles

191

9 Art, Data, and Finance: A Few Speculations About the Future 213 appe n d i x f o r po e ts i n d e x 241

viii

229

Preface

many books have been written about the art market. They cover a wide variety of topics, including how to run a gallery, legal issues associated with investing in art, how auction houses work, and the role of art dealers and art fairs. Some are very good, the best are both informative and entertaining, and the few that are bad are really awful, with errors such as misspelling the names of well-known artists such as Jackson Pollock and placing famous museums in the wrong city (e.g., the Barnes Foundation in Pittsburgh instead of Philadelphia). However, all those books share a similar trait: they are qualitative in nature. Certainly, there is nothing wrong with this approach; each book is useful in its own way and deals with an important aspect of the art market. But all those books leave a gap that needs to be filled. The art market is full of interesting financial problems that are quantitative in nature, and this book is an attempt to provide the tools to tackle some of these problems. However, this book was not born from a conscious effort to bring a more quantitative viewpoint to the analysis of art markets. Some explanation is necessary, as the genesis of this book goes back a few decades. We both grew up in Santiago, Chile, at a time when the city’s fine arts offerings were very poor. The collection in the main museum, the Museo de Bellas Artes, consisted mostly of paintings by Chilean artists who ix

Preface

had gone to Paris at the turn of the nineteenth century, where, instead of learning from the Impressionists, they chose to attend the Royal Academy of Art (École des Beaux-Arts). In addition, the museum’s collection included a number of uninspiring equestrian portraits by second-class European artists who favored only brown and black; all in all, it was a pretty unremarkable display by all accounts. We had never seen a painting that inspired us until we relocated to the United States as graduate students and, around 1982, visited the Norton Simon Museum in Pasadena, California, where we viewed Diego Rivera’s The Flower Vendor. We stood in front of that painting for a long time—it was an enlightening moment—and realized what a great painting looks like and how it can affect you. It was the beginning of our friendship with museums, galleries, exhibitions, and paintings. Before leaving the Norton Simon, we stopped at the bookstore and bought a postcard displaying Rivera’s painting of the girl with lilies, the only thing our student budget allowed. We still have it. In 1989, we moved to New York, where our relationship with art and museums evolved into a love affair that quickly became a passion that continues unabated. The turning point was probably the 1992 Henri Matisse: A Retrospective exhibition at the Museum of Modern Art. We stood in line for a long time on 53rd Street on a cold day over Thanksgiving weekend, choosing art over turkey to see the show. This time we could afford the exhibition catalog, as we were both gainfully employed. That fascination with art—with a heavy bias toward paintings—has only grown with time. Almost thirty years later, we can claim to have repeatedly visited all of New York’s important museums and many less important ones, bought what some probably view as an excessive number of books (full disclosure: not all, but most, have been read), acquired a few paintings that we still love, and frequently traveled just to see a particularly enticing art exhibition even if the location was less than appealing. For example, in 2007, we visited the Albright-Knox Art Gallery in Buffalo, New York, for the Francis Bacon: Paintings from the 1950s exhibition. Though we lack formal training in an art-related discipline, we have found all these experiences educating and illuminating. It has been a long journey with plenty of fun discoveries along the way. x

Preface

Much to our surprise, we realized that sometimes statements made by art scholars left us cold and indifferent while insightful observations made by shrewd art lovers who were trained in a field outside art resonated better with us. In particular, Art & Physics: Parallel Visions in Space, Time, and Light by Leonard Shlain, who was neither a physicist nor an art historian but a medical doctor, is, according to one of us,“by far the most intelligent and fascinating book that I have read about art.” David Galenson’s books—Old Masters and Young Geniuses: The Two Life Cycles of Artistic Creativity, Conceptual Revolutions in Twentieth-Century Art, and Painting Outside the Lines: Patterns of Creativity in Modern Art)—are examples of excellent scholarship combined with sharp and original observations about art and the art markets based on empirical evidence. Galenson is an economist who teaches at the University of Chicago. A third example is Lumen Naturae: Visions of the Abstract in Art and Mathematics by Matilde Marcolli, a Caltech mathematical physicist. Her book is more mathematically challenging than those of Galenson or Shlain, but her insights are equally instructive. It is one thing to develop a fondness for art but quite another to try to apply financial tools to the art market. That idea came to us almost accidentally about five hundred Saturdays ago during a family lunch in Santiago—that is, long after we had graduated as so-called art groupies. It occurred to us that since paintings are two-dimensional objects, by expressing their selling prices in $/cm2, we could use this metric to infer a few things about them, make comparisons, estimate returns, and so on. The idea worked, and we published a paper about this method in the Journal of Alternative Investments. Then we noticed that most quantitative research related to the art market focused on estimating returns, but many other problems had not received as much attention, such as estimating the risk in art-secured lending transactions, valuing the option associated with a third-party guarantee, and structuring a diversified portfolio by mixing stocks, bonds, real estate, and art. Thus began our relationship with the quantitative side of art, a topic on which we continue to work to this day. This book is based largely on these efforts, in addition to the notes prepared for a graduate course that one of us taught at Columbia University for three years. xi

Preface

Writing a book is never a solo effort—or, in our case, a two-person effort. You always owe a debt of gratitude to the authors who dealt with the topic before, whether or not you agree with their views. As far as we can tell, Robert Anderson was probably the first person to apply quantitative tools to the art market with the publication in 1974 of a paper in which he estimated art returns for the period 1780 to 1970. He could rightly be considered the intellectual grandfather of all the researchers working on this topic today. The late William Baumol deserves a special mention. Shortly before he passed away in 2017, he took the time to read one of our papers and emailed us some very encouraging comments. Then he apologized for taking such a long time to respond. “At age 94 I do not deal with messages as soon as is appropriate.” Not many academics—especially among people of his stature—exhibit such generosity. We also wish to thank Nicola Graham from Liv-ex for providing us with useful information about the wine market as well as data regarding some of the Liv-ex indices. In addition, we thank Jean Minguet from the Econometrics Department of artprice.com, who took the time and had the patience to answer many of our questions regarding the company’s art indices. Our appreciation extends to their respective companies, Liv-ex and artprice.com, for giving us permission to include some of their indices in this book. Luis Reyna and Carolina Dewez, steady friends for many years, have been our partners in visiting countless museums and galleries. We have benefited tremendously from our conversations with them during the course of this project. Over the years we have also benefited a great deal from conversations and interactions with many people—friends, acquaintances, and sometimes strangers—who have been generous with their time, knowledge, and opinions. Sometimes these interchanges have taken the form of long conversations, sometimes as brief as an elevator ride after a seminar, and sometimes just a sequence of brief observations delivered via email. At the risk of leaving out a few names, and apologizing in advance to those unfairly forgotten, we would like to acknowledge Andrea Abarzua, Roberto Bendersky, Hector Betancourt, Jose Luis Blanco, Claus-Christian Carbon, Monica Cavallini, Felipe del Canto, Dina Cembrano, Alejandra Cox, xii

Preface

Bruno Dupire, Sebastian Edwards, Irene Furman, David Galenson, Marina Gertsberg, Giuditta Giardini, Judd Grossman, Kate Lucas, James C. MacGee, Amelia Manderscheid, Bernardita Mandiola, Francesca Manzi, Jorge Manzi, Teruca Martinez, Michael McAdams, Maxwell Murialdo, Nancy Navarro, John O’Donnell, Bernardo Pagnoncelli, Laura Patten, Karen Poniachik, Juan José Price, Viktoria Prigarina, Denise Ratinoff, Drina Rendic, Fritz and Ingrid Reuter, Jeremy Rhodes, Benjamin Ruisch, Bernardita Sahli, Alex Torres, Giuseppe Trimarchi, Miroslav Visic, Robert Yang, Sofia Zamora, Rosario Zanetta, and Javier Zapata. One of us (Arturo) would like also to thank Clapes UC, his professional part-time home since 2017, a place where he found good friends and enjoyed interesting conversations. We are also grateful to Myles Thompson, who read our book proposal and responded very quickly with an enormous dose of enthusiasm. And his timing was perfect; when the pandemic hit the world, we had a project to work on, a project that, fortunately, did not require much moving around and could be done in seclusion. An important part of this book was written in Reñaca, Chile, while under a draconian, but ultimately ineffective, government-imposed lockdown, we looked at the Pacific Ocean, whose deep blue served as an inspiration to us (see chapter 3). Some people admit that writing a book with a coauthor—especially if you see that person every day—can be taxing. In our case, having a book to write during these COVID-19 days was a blessing, allowing us to keep our sanity. Most of the reviewing and rewriting was done in New York City, with no ocean view but close enough to the Metropolitan Museum of Art (MET) that we could visit frequently for inspiration and relaxation. Thus, in more ways than one, geographically as well as mentally, this book is the product of two hemispheres. Two final thoughts. First, although this book is quantitative in nature, it should not be seen as an attempt to overemphasize the power of quantitative over qualitative analysis in reference to the art markets. Both types of analyses are valid, and each feeds on the other. The idea that one must choose between these two perspectives is a false dichotomy that leads to a fragmented and misleading view of one of the most intriguing and complex systems: art. Therefore, this is a book for people who love art and are not afraid of looking at numbers. xiii

Preface

Second, this book is dedicated to New York City, the artistic and financial capital of the world: the city we call home, one that has been generous to both of us in many ways, a city we have learned to love and never hate, and a place we could not live without. We now invite you to listen to the numbers. They can tell you much more than words alone can ever do.

xiv

Glossary: Key Art Market and Finance-Related Terms

Absentee bid: Bid placed before an auction by a party who may not wish to attend the sale and presumably prefers to remain anonymous. Appraisal: An estimate of the market value of an artwork. Artist proof (AP or A/P): Typically relating to prints, it refers to the (usually) few copies the artists keep for themselves. They are not numbered. In theory, they are not supposed to be sold, but some occasionally reach the market. Asset-based loan: A loan in which the borrower pledges an asset as collateral in case they fail to repay the loan. Attributed (to): When the authorship of an artwork is not certain. Black list: List containing the names of flippers or potential flippers. Some art dealers and galleries try to avoid selling to flippers. (See flippers.) Blue chip artists: Generic term used in relation to artists who have proven to be solid performers from a financial viewpoint (i.e., artists with a steady market appeal). Blockchain: A system for storing information (blocks) based on a decentralized distributed ledger. It has an append-only structure, which means that files cannot be deleted or altered once added. Bought in (also buy in): An artwork that fails to find a buyer at an auction. Burned (or burnt): The artwork has suffered severe reputational damage (possibly because it has been bought in). Buyer’s premium: The sales commission the winning bid has to pay in an auction in addition to the hammer price; it is calculated as a percentage of the hammer price. Canvas: Strictly speaking, a material (cloth) commonly used as support for creating a painting. Colloquially, it can be used as a synonym of “painting.”

xv

Glossar y: Key Art Market and Finance-Related Ter ms

C ATALOGUE RAISONNÉ : A full and complete list of the artworks legitimately attributed to an artist. Certificate of authenticity: A document stating that an artwork was created by a specific artist. Chandelier bid: A fake bid in a public auction, one that the person conducting the auction purports to see in the back of the room but that does not exist. Its purpose is to encourage and animate the bidding process. Condition report: A report that contains an assessment of the physical state of an artwork. For example, the report on a painting might address the condition of the canvas (does it show any damage?), the frame (is it chipped?), and/or the painting itself (has it been retouched unprofessionally?). Consignor: The person selling an artwork. Consumer Price Index (CPI): An index prepared by the U.S. Bureau of Labor Statistics that traces the evolution of prices (inflation) based on a representative group of products and services. Curator: A person who manages an art collection or a museum. Also, a person who organizes an exhibition; that is, designs the presentation and installation, writes the explanatory material, etc. Day sale: See Evening Sale. Digital art: Art created with digital technology (a combination of software and hardware). Also, it may refer to art that is showcased with the help of such technology. D ROIT DE SUITE : A French term that refers to the right of an artist to enjoy the benefits of a potential resale of their artwork. Evening sale: Normally, auctions are scheduled in the evening (the most prestigious sales) or during the day (less glamorous sales). Fair warning: A term used by the person conducting an auction to indicate that the artwork is about to be sold to the last bidder in a matter of seconds unless a higher bid materializes. It is often used as a means to extract a higher bid. Flippers: Derogatory term used to describe people who buy artworks and sell them for a profit shortly afterward. Freeports: High-end storage facilities for artworks that offer tax-free status and other legal benefits in the country in which they are located. Sometimes they are described as “special economic zones.” Guarantee: The minimum price the auction house can ensure that the consignor will receive. If the highest bid is below this amount, the house covers the difference; for taking this risk, it charges an extra commission. (See irrevocable bid.) Hammer price: The price offered by the highest bidder in a public auction. Irrevocable bid: Same as a guarantee. When the auction house offers a guarantee, it is essentially offering the consignor an irrevocable bid. Lien: The right (typically granted to a lender) to take possession of an asset in case a borrower fails to repay a loan. xvi

Glossary: Key Art Market and Finance-Related Ter ms

Loan-to-value (LTV): In a lending operation, the ratio obtained when dividing the loan amount by the estimated market value of the collateral (the asset pledged to guarantee repayment of the loan). Lot: Generic term for an item to be auctioned. It can be, for example, a painting or a classic watch. Medium: The material or chemical substance used to create a painting or drawing (e.g., oil, tempera, ink). Nonfungible token (NFT): A block (file or record with information) stored on a blockchain; it represents ownership of a digital or physical asset. The nonfungible aspect means that the token is unique—unlike, for instance, bitcoin or any other cryptocurrency that is fungible. Nonrecourse loan: A loan arrangement in which the lender has no right to go beyond the pledged asset (collateral) in case the borrower defaults and the sale of such asset fails to cover the amount that is owned. Party with an interest: Normally refers to a party that has made an irrevocable bid before a public auction. Premium price: The total amount to be paid by the winning bid in an auction (hammer price plus buyer’s premium). Primary art market: Refers to the first time an artwork is sold; essentially, from the artist either directly from their studio or through a gallery. Provenance: A record of ownership of an artwork, ideally covering the entire life of the artwork, from its creation to its present owner. Recourse loan: A loan arrangement in which the lender has the right to go beyond the pledged asset in case the borrower defaults and the sale of such asset fails to cover the amount owned. In these cases, the lender may try to gain control of other assets of the borrower. Resale royalty: See DROIT DE SUITE. Reserve price: The lowest acceptable price in a public auction. If the highest bid is below the reserve, the artwork will not be sold (it is bought in). Secondary art market: Artworks that are resold, most likely through an auction house or in a private transaction arranged by a dealer. Secured loan: A loan arrangement in which the borrower has pledged an asset to guarantee repayment of the loan. If the borrower defaults on the loan, the lender can seize the asset. Seller’s commission: The commission paid to the auction house by the seller or consignor. Smart contract: A contract between two parties in which the details of the agreement are captured in a piece of software, unlike a conventional contract, whose details are contained in a written agreement. If certain conditions are met, the contract (software) executes the instructions. Support: The surface on which a painting is executed (e.g., canvas, paper, wood, a wall). xvii

Glossar y: Key Art Market and Finance-Related Ter ms

Third-party guarantee: Another party (e.g., hedge fund, private investor) enlisted by an auction house to take the risk in a guarantee. In essence, the house transfers the risk to a third party in exchange for a fee. Token: A record of ownership registered on a blockchain. See also nonfungible token. Tokenization: Refers to the dividing of ownership of an artwork (fractional ownership) in equal proportions, each one represented by a token. These tokens are fungible, representing identical proportions of ownership. Uniform Commercial Code (UCC): The set of laws that governs commercial transactions in the United States. V ERNISSAGE : A private viewing of an exhibition, typically before it opens to the general public. Verso: The back side of a painting. Withdrawn (or withdrawn lot): An artwork that is removed from the auction before the auction takes place for a number of reasons; for example, the artwork may be perceived to fail to meet the reserve price, or legal issues associated with the potential sale have been discovered.

xviii

PART I Understanding the Art Markets

Introduction

artworks have a dual nature: contemplating them can provide aesthetic pleasure, and they can also be valuable financial assets. This book lies at the intersection of these two fields: art and finance. Or, perhaps more accurately, it addresses the vast domain where they overlap. Our thesis is simply that the information provided by the prices paid for artworks is useful for drawing important conclusions about what their value could mean for people who are thinking about investing in art. Not surprisingly, most of these conclusions can have a direct bearing on purely financial decisions; for example, whether buying a Futurist painting could improve the risk-return profile of a portfolio made up of stocks and bonds. Perhaps less obvious is that prices can offer insights into debates that, until recently, were thought to be the exclusive domain of professionals such as experimental psychologists (Do people prefer blue over other colors?) or art critics (Was Matisse a revolutionary artist or an experimentalist?). Some people might find it offensive that the words “art” and “finance” are used in the same sentence, since art is perceived as pure and pristine while finance is inextricably linked to money, which is sometimes considered tainted. The reality, however, is that the relationship between art and money goes back many centuries. There is evidence that rich Greeks and Romans commissioned artworks, which—and this is not a minor 3

Understanding the Art Markets

detail—allowed artists to make a living doing what they liked and were good at. The art market, in the sense that we understand the term today—the meeting of buyers and sellers aided by a number of third parties such as auction houses, galleries, critics, dealers, art fairs, museums, and curators—is a more recent development, but it is probably safe to say it is at least two hundred fifty years old. The birth of the art market more or less coincided with the Industrial Revolution; in fact, Sotheby’s and Christie’s, the two auction houses that continue to dominate the secondary market (an important element of any financial market), were founded in the eighteenth century. In addition, the production of art for sale—as opposed to art produced in response to requests by specific clients—which is a necessary element for a dynamic supply-and-demand interaction, was also an eighteenth-century innovation. However, the bottom line is that prices are proxies for preferences, and today’s secondary art market generates enough observable prices to enable a wide range of analyses. This book is based on the premise that the use of financial tools, combined with the empirical evidence provided by prices paid for artworks, can offer valuable insights about those works—and the art markets— from an investment as well as aesthetic viewpoint. By financial tools, we mean some of the statistical and modeling techniques used to analyze investments of other kinds. We use as building blocks information about paintings that have been sold in public auctions; that is, data related to artists who enjoy a certain amount of prestige. New and upcoming artists normally sell through galleries (the primary market) before they acquire a strong presence in the secondary market. Auction sales account for roughly half of all art market sales; the remaining half comes about through private sales arranged by dealers or other intermediaries. Empirical and anecdotal evidence indicates that these two markets are fairly aligned in terms of prices. Therefore, prices achieved at auctions are reliable indicators of market appeal. Note that a number of academics like to mention that art market auction data may suffer from selection bias, since they relate only to artworks that have found a buyer. This assessment is unwarranted and, in fact, could also be claimed about the stock market or real estate market, as all the relevant 4

Introduction

market indicators are based only on stocks traded or houses sold. This point is discussed in more detail in chapter 4. In chapter 8, we show how to use the techniques that we have applied to the art market to other collectibles. Readers who are curious about the history and evolution of the art markets may find it useful to peruse chapter 2 of the Handbook of the Economics of Art and Culture, volume 1, edited by Victor Ginsburgh and David Throsby. Those more interested in the current inner workings and dynamics of the art market should read Seven Days in the Art World by Sarah Thornton, The $12 Million Stuffed Shark: The Curious Economics of Contemporary Art by Don Thompson, or The Value of Art by Michael Findlay. A few clarifications regarding the art market are needed at this point. First, strictly speaking, there is no such thing as the art market; rather, there are several distinct segments, each with a different dynamic. For instance, the market for sculptures is different from the market for paintings, and photographs behave differently from either antiques or video installations. Second, the art market retains certain features relatively uncommon in more developed financial markets (e.g., stocks, commodities, currencies): low liquidity, high transaction costs, a great deal of opacity, and many conflicts of interest as a result of lack of regulation. Third, and most important, for all its progress in recent years, the art market is still small—Nasdaq trading in one day is three times what the art market trades in one year. A unique feature of the art market is that despite its small size, it punches far above its weight, at least in terms of media and public attention. No doubt part of the reason is the colorful cast of characters who populate the art world—not only the artists but also dealers, critics, hangers-on, and smooth operators—combined with the attention grabbed by the high prices paid for some artworks (for example, at least five Picasso paintings have fetched more than $100 million). And, of course, part of the reason for all this attention is that art matters. Not for nothing have humans been producing art for at least fifty thousand years, probably since they developed the capacity for abstraction. Also, the constant hostility of authoritarian and religious leaders toward certain art highlights its power to influence minds. (For example, think 5

Understanding the Art Markets

of Hitler and his fight against “degenerate” art or more recently, former New York City mayor Rudy Giuliani, who, in 1999, attempted to shut down Sensation, a Brooklyn Museum exhibition he deemed offensive.) These observations might be dismissed as theoretical considerations that matter only to legal scholars or philosophers. But the reality is that people in general do care about art. One example: in 2017 in New York, Christie’s auctioned Salvator Mundi, a painting by Leonardo da Vinci— although there are still some lingering doubts regarding the attribution— for $450 million. More than twenty thousand people stood in line, some for many hours, to visit the painting’s exhibition. The relationship between art and science—or, more precisely, between art and a number of methods and techniques based on scientific advances— also goes back many centuries. Recall that da Vinci was not only a great artist but an accomplished engineer and polymath. Gothic cathedrals were built by people who had not only aesthetic sensibility but also knowledge of the strength of materials and structural design. Additionally, prior to the nineteenth century, most artists had to create their own paints and thus needed to understand the properties of different pigments and certain binding materials. In the last thirty years, advanced materials science techniques such as X-rays, microspectroscopy, infrared reflectography, and mass spectrometry have proven to be highly effective in identifying forgeries. Notwithstanding those examples, some artists who have neglected science in their productions have often paid a heavy price. Perhaps an extreme case is that of Damien Hirst. The shark that he cut in half, put in a formaldehyde solution, and named The Physical Impossibility of Death in the Mind of Someone Living did not live long, metaphorically speaking. The solution he used was the wrong one if his intention was to design a long-lasting artwork, since the formaldehyde failed to prevent decomposition. Conservation experts suggest that in these types of cases, alcohol-based solutions are more effective. Fifteen years after creation of the artwork, the original shark had to be replaced due to its sorry state of decay. Chemistry matters! The use of data-driven quantitative techniques applied to issues related to art and art markets is more contemporary. For example, in recent years, prestigious scientific journals (e.g., Science, Nature) have 6

Introduction

published articles demonstrating the usefulness of computational and artificial intelligence algorithms for quantifying reputation in the art market, classifying paintings according to their style, and explaining how aesthetic preferences are formed. Given this background, it is surprising to note the skepticism expressed by some so-called art experts (e.g., art market advisers, art historians) regarding the benefits of using quantitative techniques to illuminate questions about the art market. To be clear, we are not suggesting that experience does not count when making a statement (financial or aesthetic) about an artwork and that pronouncements based only on computer analysis are valid. But failing to see the supplemental value of such analyses amounts to holding unscientific attitudes rooted in hostility toward empirical evidence. This attitude is tantamount to that of a physician expressing the view that medical expertise makes a blood test or MRI result irrelevant. We mention this because over the years, we have heard a number of variations of the following statement: “Art is different; you cannot say anything interesting or useful about art or the art market based on quantitative techniques.” Obviously, we beg to differ. And other authors have expressed similar views. David Galenson, in the preface of his insightful book Conceptual Revolutions in TwentyCentury Art, makes a similar point, perhaps more forcefully, in reference to art historians who “refuse to acknowledge the value of quantitative methods.” John Brewer, on the last page of his compelling The American Leonardo, concurs, referring to the cavalier attitude of some members of the art world who frequently deliver quantitatively groundless statements about the value of an artwork. To reinforce the importance of applying a scientific approach to art valuation, our aim is to show how the techniques employed in finance can be used to address questions related to art investments or the art market in general. To be clear, our intention is not to anticipate which artists are going to be hot in ten years or make predictions about the performance of the art market. Some readers may be disappointed to know that, but in fairness, we should not expect that a book about, for example, fixed income securities will tell us which bonds will default next year or when the yield curve will be inverted again. One should expect, nevertheless, that such a book would explain how to compute 7

Understanding the Art Markets

bond returns and durations and clarify the relationship between bond prices and interest rates, and that it would describe how to build an efficient bond portfolio for a given risk level or price a bond with an embedded call option. With all that in mind, our aspiration is humbler. It is simply to answer questions such as these. • How did Basquiat, as an investment, compare with the S&P 500 over the last twenty years? • Can we alter the risk-return profile of a stocks and real estate portfolio by adding Andy Warhol? • How do we assess the financial risk associated with offering a guarantee in an art auction? • How much would you be willing to lend a collector who offers five Matisses as collateral? Would that amount change if the borrower then proposes as collateral a single painting by Modigliani? • Does the orientation of a painting (landscape versus portrait) affect its price? • Do the attributes of the color palette in a painting by Mark Rothko or David Hockney explain its price? This book is intended for people who have an interest in the art market (e.g., investors, wealth managers and financial advisers, dealers and auction house professionals, art lenders, and art appraisers and insurance adjusters) and who have some understanding of notions related to finance and/or statistics. It is also intended for readers who are simply curious about the use of quantitative techniques to validate, disprove, or examine some observations made by art scholars based only on “The Eye,” the term employed by Philippe Costamagna to refer to the knowledge accumulated over years of experience looking at art. To briefly detour from art, let us start by saying that in science, the empirical evidence matters. In fact, it is the only thing that matters, for any theory or model that is disproved by empirical evidence is discarded. Empirical evidence is at the heart of this book, in the sense that our approach is to “let the data speak”—price data in our case. And our intention is to provide the reader with the tools to pay attention to the 8

Introduction

data. Therefore, we make the claim—although this could be misinterpreted as an act of extreme arrogance—that our approach aims to be scientific and not speculative. Ultimately, we strive to be practical, offering tools to gain useful insights into the art market. Readers hoping to find ambitious and grandiose models based on dubious concepts such as rational behavior, utility theory or any of its numerous variations, market signaling, market equilibrium, homogeneous agents, or emotional dividends—needless to say, all based on questionable assumptions and not a pinch of reality—are advised to look elsewhere. Finally, a few comments about the organization of the book. The first part deals with a general understanding of the art markets. The ideas introduced in chapter 1 on how to estimate returns in the context of artworks are used throughout the book. The remaining chapters are largely self-contained and can be read independently. Chapter 2, which is mostly based on prices per unit of area ($/cm2) paid for paintings, shows how, with simple calculations, we can detect trends and make interesting comparisons. Chapter 3 explores the relationship between prices and the characteristics of the painting’s color palette. Chapter 4 discusses art market indices. The second part is devoted to investment strategies. Chapter 5 looks at art investments from a risk and return viewpoint and demonstrates how they can benefit or hurt an existing portfolio. Chapter 6, on art-secured lending, introduces techniques to assess risk from the perspective of the lender. Chapter 7 deals with guarantees; essentially, how to measure risk from the standpoint of the auction house and the third-party guarantor. Chapter 8 is an overview of the collectibles market. Some collectibles (wine and cars, for example) do not truly fall under the umbrella of art; however, many of the statistical techniques applied to the art market can be used to study collectibles. In chapter 9, we speculate about the future of the art markets and the potential implications of recent technological advances in computer science and cryptography. Chapters 5, 6, and 7 are the most mathematically involved, as the derivation of a few expressions requires some knowledge of calculus. Reading chapter 7 requires some familiarity with financial options, and a rudimentary understanding of Monte Carlo simulations will help when reading chapters 5 and 6. Nevertheless, using the methods and formulas 9

Understanding the Art Markets

introduced in these chapters can be done without danger of misapplication even if one has not followed the derivation of the key expressions in detail. In summary, any reader with an undergraduate-level statistics course under their belt will be comfortable with most of the material. And we believe that the main ideas behind the analyses presented can be grasped even without a formal mathematical background. One thing is not negotiable, however: if you have never been moved by a painting—in essence, never experienced an “OMG!” moment in front of a canvas—this book is not for you, even if you read and understood Andrew Wiles’s proof of Fermat’s last theorem. In summary, as we stated in the preface, this book is for people who are not afraid of numbers, but they must love art in its many manifestations.

Suggested Readings Amore, Anthony M. 2016. The Art of the Con. New York: St. Martin’s Griffin. Brewer, John. 2009. The American Leonardo: A Tale of Obsession, Art and Money. New York: Oxford University Press. Charney, Noah. 2015. The Art of Forgery: The Minds, Motives and Methods of Master Forgers. London: Phaidon. Findlay, Michael. 2014. The Value of Art: Money, Power, Beauty. Rev. ed. New York: Prestel. Galenson, David W. 2001. Painting Outside the Lines: Patterns of Creativity in Modern Art. Cambridge, MA: Harvard University Press. ——. 2007. Old Masters and Young Geniuses: The Two Life Cycles of Artistic Creativity. Princeton, NJ: Princeton University Press. ——. 2009. Conceptual Revolutions in Twentieth Century Art. Cambridge: Cambridge University Press. Ginsburgh, Victor A., and David Throsby, eds. 2006. Handbook on the Economics of Art and Culture, vol. 1. Amsterdam: Elsevier. Hook, Philip. 2016. Breakfast at Sotheby’s: An A–Z of the Art World. London: Particular Books. Marcolli, Matilde. 2020. Lumen Naturae: Visions of the Abstract in Art and Mathematics. Cambridge, MA: MIT Press. Shlain, Leonard. 2007. Art & Physics: Parallel Visions in Space, Time, and Light. New York: William Morrow/HarperCollins.

10

Introduction

Thompson, Donald N. 2010. The $12 Million Stuffed Shark: The Curious Economics of Contemporary Art. New York: Palgrave Macmillan. Thornton, Sarah. Seven Days in the Art World. New York: Norton, 2009.

NOTES: The auction data (raw data) used to prepare the examples, calculations, tables, figures, and analyses that appear throughout the book were obtained from artprice.com and artnet.com. We processed and aggregated the data ourselves and used them as input for the subsequent calculations. The data related to the S&P 500 and investmentgrade bonds (VFSTX) were downloaded from yahoo.finance.com. Data regarding the price of gold and the U.S. real estate market (S&P/CaseShiller 20-City Composite Home Price Index) were obtained from the St. Louis Fed website (fred.stlouisfed.org). Data about the Consumer Price Index (CPI) were obtained from the U.S. Department of Labor (https:// data.bls.gov/cgi-bin/surveymost?bls). The statistical analyses for all the examples in the book were carried out with SAS, a commercially available statistical software suite developed by the SAS Institute based in North Carolina. It runs on a number of operating systems and in both personal computers and mainframes. The same calculations could have been performed using other statistical packages such as STATA, SPSS, MATLAB, R, or Statistica. More advanced users, however, may prefer to develop their own solutions or tinker with open-source tools such as Stats SciPy. Anyway, the information about these tools should not be taken as an endorsement (or criticism) of any of them. Finally, it is also necessary to mention (again, without the intention of offering any endorsement) that many vendors provide statistical analyses for the art market either through their internet platforms or customized reports. Their products are wide ranging, from a fairly conventional price index for some broad market segment to an in-depth market analysis for a specific artist. Some of these platforms and companies include Art Market Research, ArtBnk, ArtBusiness, artnet.com, artprice.com, ArtTactic, and MutualArt.

11

1

Estimating Returns in the Art Market

as we explained earlier, paintings and, more broadly, art objects serve a dual purpose: they offer aesthetic pleasure and are also financial assets. Their financial value can be described in terms of price, historic and potential future returns, liquidity, tax-related issues, and trade restrictions (especially in relation to international transactions), among others. With those financial considerations in mind, in this chapter we begin by concentrating on the most basic—and most important—attribute of an investment: the return. We explain how to estimate returns in the context of the art market using three approaches: repeat sales, hedonic models, and a crude but useful method based on the price per unit of area. We also highlight some important differences in calculating returns between the art market and other, more conventional, markets such as stocks, bonds, and commodities.

Basic Definitions The return on an investment reflects how well (or poorly) the investment performed. It describes the change in value between two reference points and is generally expressed as a percentage. More formally, if V1 and V2 12

Estimating Retur ns in the Art Market

denote the value of an asset or investment at two points in time, t1 and t2, then, the return R is defined as V2  V1 V2 R (1.1) 1 V1 V1 where we assume that t1