A New Model Says If an Infrastructure Asset Price Is Right

An asset-pricing model developed by Carlo Chiarella, Carlo Favero, and Stefano Gatti significantly reduces the risk of overpaying for infrastructure assets. The model is the result of the second year of the research plan carried out under the Antin IP Associate Professorship in Infrastructure Finance, held by Professor Gatti.

The main insight of the work is the adoption of an integrated approach to modeling infrastructure asset pricing and its returns. Up to now, asset pricing and the short run dynamics of returns had usually been studied separately.

In the first place, the scholars show the existence of a long run equilibrium relation between prices and a parsimonious set of risk drivers, built on both traditional and infrastructure-specific asset pricing factors. In other words, they show how prices depend on a set of risk drivers including market trends, the size of the project, profitability, liquidity, regulation etc.

Second, they find that the difference between the actual price and the long run equilibrium price is correlated to infrastructure asset returns at a lagged time. The correlation is negative: when the price is higher than the equilibrium price, returns will be lower at a lagged time. This means that deviations from equilibrium prices are temporary. Over sufficiently long time horizons, any deviation from long-term price equilibrium determines a price adjustment in the following period that strongly affects returns, generating some relevant predictability.

Research conducted in the first year of the Professorship found that too much money is flowing into infrastructure as an alternative asset class. Subsequent industry surveys and the amount of money available and ready to be invested in infrastructure (which reached a record peak of $200bn) suggest that the risk of overpaying is on the rise, thus making more and more urgent the construction of a model capable of assessing the congruity of current prices, such as this one.

"Our novel approach to the pricing of infrastructure assets provides a rigorous theoretical framework to better understand the dynamics of equilibrium prices and to identify the risk drivers, which are priced into infrastructure assets," Professor Gatti says. "Moreover, our approach allows asset managers and investors to assess when and where observed asset prices are temporarily under- or overvalued, either in absolute or in relative terms. Finally, our analysis provides groundbreaking evidence of some short term predictability in asset returns that asset managers and investors could exploit to generate superior performances."

Carlo Chiarella, Carlo Favero, Stefano Gatti, "A Factor Equilibrium Correction Model Approach for Infrastructure Asset Pricing", working paper.