Art Prices - A Study of Picasso

When the question of valuing art arises, many argue that the very essence of art is beyond economic calculation and reasoning. They claim that its very 'raison d'être' is that it is set apart from such material considerations. However, given the multi-million pound global industry that is art, this tenet is unrealistic to say the least.

Valuing any commodity is simply the act of assessing whether it is worth its price. This means calculating whether the object is worth the other things that could be bought for the same amount. People in the arts do this as much as anyone else, despite their fondness for asserting that money should not interfere with considerations of artistic merit (Grammpp, 1989). Although there are many determinants in the production and consumption of art, Frey and Pommerehene (1989) state that there are very useful insights to be realised from taking an economic view of art. Art, like all other goods, is subject to scarcity and hence restricted by the scarce resources available. Its production and consumption are the result of the maximising behaviour of individual agents, which creates market demand and supply.

This essay will overview the art market and investment in art. It will then look at possible factors which may affect prices in it. The analysis looks at possible factors affecting the price of one artist's painting, Picasso, in a given auction season. From this, it is concluded that factors affecting prices are possibly too complex to be modelled in this simple regression, and given their number and variety, investment in art can be a risky, albeit pleasurable experience.

Artists (and their dealers) as the basic suppliers to the market act like any other economic agents, taking into account the benefits and costs of alternative actions in pursuit of their own interests. Although the number of works of deceased artists is obviously given, supply of work by contemporary artists can be expanded by increased production. How many works produced will depend on the marginal input costs of production (which increases prices) and the expected future value of their work.

Demand on the other hand is basically a function of the income of potential buyers (which has a large positive effect), prices of art (small and negative), and the rate of return available on alternative investments (Frey and Pommerhene, 1989). Investing in an art object provides two main sources of utility or returns for a consumer:

• 'Psychic' returns: which can offer utility in the form of civic utility (from an altruistic need to support art or artists in society), functional or decorative utility (from the need for decoration or collecting art to adorn or display), or ostentatious or prestigious utility (derived from the prestige or status gained from owning especially famous pieces of art);
• Financial returns: from the prospects of profiting from an art investment due to a change in its value which is a function of expected rate of return and risk (Rouget et al,1992).

Candella and Scorcu (1997) conducted a study to assess whether it was rational for an investor to purchase a piece of art as opposed to another store of value such as government bonds, shares or real estate. They found that the estimated return on paintings was clearly lower than the corresponding average yields on government bonds and other stocks. Also regarding risk, art objects were found to yield the going rate for their systematic risk plus their value contained a substantial element of non-systematic risk. Risk in art is not simply confined to uncertainty regarding future prices but also includes risks such as attribution, fakes, forgeries, and material risks of damage destruction and theft (which increase its maintenance, insurance and restoration costs). Their findings corroborated many other previous studies such as Baumol (1986) who found that the real rate of return on paintings was only 0.5% as compared to 2.5% on government bonds concluding that art was not a superior investment or a profitable way to speculate. However, Frey (1997) points out that many of these studies neglect the possible tax advantages of investing in art as well as the point that economists are really at a loss when it comes to evaluating subjective psychic benefits, often using residual measures which may understate this component of returns.

In the late 1980s the art market experienced a huge cash injection with the appearance of a new breed of investive collectors speculating mainly on modern art as it offered the most leeway in price and return. However, excessive speculation and exogenous factors caused prices to plummet in the early nineties as these investors got rid of their art in the recession. Although the market has recovered considerably, expectations for the future are that more works will come onto the market and average prices will fall.

Price fluctuations in the art market are unpredictable as they are not limited simply to the production costs or income of a firm. This has discouraged the cautious investor, despite possibly huge profits for certain players. There are a wide range of factors that influence the price of paintings which can be broken down into four main categories (Rouget, 1992; Czujach, 1997).

The price of a painting will depend greatly on the role the artist has had in the history of art and the fame they acquired. The fame of a particular movement that an artist belonged to, his place, and innovation in it gives a hierarchy of value to art. The importance of such factors is often decided by a minority of art experts. An artist's reputation affects the economic value of art by increasing the prestige or ostentatious utility derived from its consumption, as well as reducing financial risks compared to investment in relatively unknown work. The 'fame phenomenon' in art is a means to save information costs and reduce risk in the purchase of art, which justifies the higher prices attained.

Prices of works of art also depend on their artistic quality, authenticity, and other technical factors. Artists' work can often be divided into early, transitional, and mature works, with periods often used as approximations for quality. Higher prices are generally paid once the artist has established his own form or style.

The subject of the work is also a factor although this may largely depend on the preferences of buyers - for example male buyers are said to prefer the female form in representational work, they will hence pay a higher price for it. Artists' favourite subjects also sell better than non-typical works as they act as a recognisable trademark. However, subject has lost its economic and artistic supremacy in contemporary art.

Technical characteristics are also important in that if paintings are deemed to be of a similar quality, prices may vary according to size and techniques used. For example, it is assumed that oils are more expensive than other media due to higher production costs and greater durability. The effects of size are less straightforward. One would expect large works to reach higher prices, yet many studies have shown that whilst price does rise with size it does so at a decreasing marginal rate. Although production costs do increase with size, many collectors prefer smaller paintings that they can exhibit or hang on their walls at home. This means that the average collector will have less demand for large works thus reducing their price. In addition, large museums and galleries, which would be the main purchasers of large works, have considerable negotiation power as they will display the work publicly to the benefit of the artist, having a similar effect on price.

Authentic works often earn higher prices due to the reassurance of genuineness, as well as prestige if visible. Doubts regarding origin will greatly reduce value, therefore registration in established sales catalogues, proof of previous ownership, and other guarantees will add to authenticity, assurance, and therefore price.

The relationship between supply and demand of works of art helps to define their relative rarity, and hence their price. If a rare piece of work comes on sale there may be many competing purchasers who could drive up its price (if it is a recognised or fashionable work). However, the fame of a work will often depend on how many people have seen it, therefore it can not be too scarce as a minimum number of works are needed to spread information on the artist's reputation and give people the motivation to buy. For this reason, works that have been exhibited more often will usually obtain a higher price, although record prices have been gained when famous works come out of a private collection which have not been seen for years.

Works sold in large and famous museums or galleries often achieve high prices as they signal quality work to buyers. In addition, they contribute to the spread of information via large exhibitions and well promoted sales, often attracting prestigious collectors. Rich and well known buyers may not only offer greater amounts of money for art (as they have relatively inelastic price elasticity of demand schedules) but also increase possible resale values by bringing renown to the painting or artist.

Salamon (1992) also found a significant relationship between presale price estimates published by auction houses and the actual price achieved. These estimates are an indicator of the 'hammer price' expected, the seller's reservation price, and possible resale value of the art. As such, low price estimates often attract buyers to an auction whilst high estimates often attract sellers. Moreover auctioneers were found to display genuine expertise in predicting what price the art would sell for at auction.

The actual salesroom itself and where it is located may also affect price. New York and London are the international centres for world trade in art with around 70% of the auction market they also achieve the highest prices at auction. The existence of different tax rates and regulations may also influence the price and location of exchange. A possible factor for the focusing of the industry in these two cities is that neither imposes resale royalties, although it is likely that historical and other factors also affect their dominance. Sotheby's and Christi's are the dominant auction houses world wide, and as such command the highest prices (largely due to their volume of trade).

There are contradictory views about the effects of macroeconomic factors on the price of art. Demand for art as a luxury good is positively correlated with income, therefore if supply is stable, increased demand from increased income should increase prices, hence the art market should mimic general economic conditions.

Investors may also consider art as a way of hedging for inflation. In periods of high inflation, risk associated with financial assets increases, thus demand increases for material or non-financial assets such as art, however, no stable relationship has been found between inflation and art as an inflation hedging investment.

Whatever their effects, macroeconomic factors will tend to affect aggregate art prices as opposed to other factors which will have a variable role depending on the artist or work exchanged.

Overall, what really drives value and prices on the art market is still relatively mysterious and complex and it is impossible to rely on any one factor exclusively in order to predict price changes.

Given that Picasso's work is generally in similar condition and widely recognised we need not account for these factors in the analysis.

Picasso's work is regarded as amongst the highest quality in the history of art. He has also sold a huge volume of paintings, has three entire galleries devoted exclusively to his work (in Paris, Barcelona, and Antibes), and thousands of other pieces in museums and galleries world wide. Walther (1994) states:

'...Picasso's creations are not merely part of the sum total of 20^th century art, but rather are seen as its icons. 'Guernica' is unquestionably the most famous modern painting world wide, matched as an art classic only by works such as Leonardo's 'Mona Lisa'...'

As discussed in the previous section there are a large number of variables that may influence the price of paintings even if only considering one artist. The data source for this analysis is the Art Sales Index 1995/1996 (Hislop, 1996), which is a published price listing of all registered sales for that season. Although the source was useful in providing a reasonable sample size (285 Picasso paintings), it did limit choice and quantity of X variables available for analysis. The fact that this analysis is limited to only two independent variables limits the conclusions of the analysis.

The first independent variable used, X1, represents the dimensions of the paintings in square inches. The price of producing a square inch of a large painting is no less than that of a small one, therefore larger works should command proportionately higher prices. But as previously mentioned, the average buyer wants works they can display with ease hence this may reduce the demand for very large works. As these figures are obtained from public auction, it could be expected that this effect would dominate prices. Therefore paintings in the small to medium range may have the highest prices, and so price and size are expected to have a negative relationship.

The second independent variable X2 relates to the year in which the piece of art was created. Picasso had eight distinctive working periods during which the quality, the number of works produced, and the influence they had on the art world varied greatly. From this, it is expected that work created in the Blue, Rose and Childhood periods would fetch the highest prices (See Appendix 1). As these are his earlier periods, it is expected that price and year will have a negative relationship.

In this analysis the ordinary least squares technique is employed which yields a line of best fit according to the data given. The model therefore takes the form:

Y =b o+b ₁X₁+b ₂ X ₂ +m

Y= 20,600,000+382.7 X1-10,543.5 X2

From a superficial analysis of the signs and size of the variables, it appears that painting size is positively correlated with price, whereas the relationship that was expected was negative. This could imply that the negative price effect discussed only applies to very large cumbersome works, which were not contained in this sample. It could be that the intuitive idea is correct - people prefer large paintings but only up to a certain limit. Nothing definite can be concluded from the analysis as there were no extreme sizes in the data. The large negative coefficient for X2 indicates the expected result - that the paintings of Picasso's earlier years attain higher prices than his more recent work.

Examining the t-statistics and probability values, it can be seen that both variables are significant at the 5% level. In other words, if we consider the hypothesis that there is no relationship between the X and Y variables, the t-statistic (which represents the ratio of the estimates to the standard error) indicates that we should in fact reject this. Both of the estimated coefficients are significant at the 5% level. The F-statistic of 10.5 (at zero probability) also implies that we reject any hypothesis that b ₁ =0 and b ₂ =0 or that the model has no explanatory power.

However, examination of the R² indicates that only 7.6% of the variation in Y can be explained by the linear influence of the two independent variables (noting that the linear form is acceptable in the diagnostic tests). This indicates as predicted that there is a lot of unexplained variation in price or 'noise' that is not explained in this simple model. Although there appears to be no problem with heteroscedasticity, the serial correlation results indicate that the errors are not in fact random, which suggests that we have possibly left out important explanatory variables. There is also a high level of noise.

The single regressions of X₁ and X₂ on Y individually show the significance of the variables individually but with an even poorer R². The two independent variables were regressed against each other and their estimated correlation does not show any problems of multicollinearity. It was found that most paintings of a high price were in the small to medium range, with an interesting peak value of over £10 million for one of the smallest works. Most of the best sellers are pre 1940 with a peak price in the late 1930's (possibly a spin-off from Guernica).

Overall there is a strong indication that despite the possible importance of these variables, they are certainly not sufficient to explain the price fluctuations in these works and a much more complex multi-variable model may be needed.

The most obvious conclusions that can be drawn from this analysis are that there are many, varied factors that play a part in determining the prices of works of art. Picking one variable even as strong as the international fame of the artist does not (even) guarantee any standard price, as can be seen from the wide range of prices in Picasso's work for just one season.

Although art prices again seem to be on a rising trend, the differences in estimates and the uncertainty inherent in markets such as these would warn away those who do not love risk. That is not to say that there are not investors making huge profits from their artistic assets, but that many of these are wealthy collectors whose large portfolio size ensures profitability and reduced risk. It must be remembered that investment in art is not all about making money. The more subjective psychic returns that an individual derives from owning a piece of art may be enough for the individual to purchase it without regard for pecuniary matters. In conclusion, however, it is wise to heed Grammpp's warning to the naive and amateur investor in the art world:

'...if they love art as well as risk, the art market can be their playground... however the prudent amateur- the art lover who is not a risk lover- buys art for the pleasure of owning it. He invests or speculates in other things...' (Grammpp,1989:166)