Evaluating the potential for statistical decadal predictions of sea surface temperatures with a perfect model approach

We explore the potential for making statistical decadal predictions of sea surface temperatures (SSTs) in a perfect model analysis, with a focus on the Atlantic basin. Various statistical methods (Lagged correlations, Linear Inverse Modelling and Constructed Analogue) are found to have significant skill in predicting the internal variability of Atlantic SSTs for up to a decade ahead in control integrations of two different global climate models (GCMs), namely HadCM3 and HadGEM1. Statistical methods which consider non-local information tend to perform best, but which is the most successful statistical method depends on the region considered, GCM data used and prediction lead time. However, the Constructed Analogue method tends to have the highest skill at longer lead times. Importantly, the regions of greatest prediction skill can be very different to regions identified as potentially predictable from variance explained arguments. This finding suggests that significant local decadal variability is not necessarily a prerequisite for skillful decadal predictions, and that the statistical methods are capturing some of the dynamics of low-frequency SST evolution. In particular, using data from HadGEM1, significant skill at lead times of 6–10 years is found in the tropical North Atlantic, a region with relatively little decadal variability compared to interannual variability. This skill appears to come from reconstructing the SSTs in the far north Atlantic, suggesting that the more northern latitudes are optimal for SST observations to improve predictions. We additionally explore whether adding sub-surface temperature data improves these decadal statistical predictions, and find that, again, it depends on the region, prediction lead time and GCM data used. Overall, we argue that the estimated prediction skill motivates the further development of statistical decadal predictions of SSTs as a benchmark for current and future GCM-based decadal climate predictions.

The inflation hedging characteristics of US and UK investments: a multi-factor error correction approach

Historic analysis of the inflation hedging properties of stocks produced anomalous results, with equities often appearing to offer a perverse hedge against inflation. This has been attributed to the impact of real and monetary shocks to the economy, which influence both inflation and asset returns. It has been argued that real estate should provide a better hedge: however, empirical results have been mixed. This paper explores the relationship between commercial real estate returns (from both private and public markets) and economic, fiscal and monetary factors and inflation for US and UK markets. Comparative analysis of general equity and small capitalisation stock returns in both markets is carried out. Inflation is subdivided into expected and unexpected components using different estimation techniques. The analyses are undertaken using long-run error correction techniques. In the long-run, once real and monetary variables are included, asset returns are positively linked to anticipated inflation but not to inflation shocks. Adjustment processes are, however, gradual and not within period. Real estate returns, particularly direct market returns, exhibit characteristics that differ from equities.

Hedging private international real estate

The performance of an international real estate investment can be critically affected by currency fluctuations. While survey work suggests large international investors with multi-asset portfolios tend to hedge their overall currency exposure at portfolio level, smaller and specialist investors are more likely to hedge individual investments and face considerable specific risk. This presents particular problems in direct real estate investment due to the lengthy holding period. Prior research investigating the issue relies on ex post portfolio measure, understating the risk faced. This paper examines individual risk using a forward-looking simulation approach to model uncertain cashflow. The results suggest that a US investor can greatly reduce the downside currency risk inherent in UK real estate by using a swap structure – but at the expense of dampening upside potential.