How do you value art? How do you price art?

There is a prevailing belief, particularly in the upper echelons of the contemporary art world, that art makes a great investment. (For a good overview see Caslon Analytics art fund note.) However, research shows that in the overwhelming majority of cases, art is neither a good nor efficient investment. (This is discussed at length by authors Alan Bamberger, Don Thompson and Sarah Thornton.) While successful sales are lauded in the media, for every success there are far more untold failures. Author Don Thompson notes that in fact, the Mei Moses Index, used for tracking the value of museum-quality art, excludes works that auction houses have refused for resale which means that only successful artists - those with rising values at auction - are counted. That is like looking only at stocks from the S&P 500 Index that have increased in value and concluding that investment in shares is a good thing. Thompson goes on to say that most art will not appreciate, and there are high transaction costs such as dealer markups, insurance, taxes, capital gains. Eighty percent of art bought from local dealers and local art fairs will never resell for as much as the original purchase price.

Recent research by the Stanford Graduate School of Business on the value of art as an investment validates Thompson's assertions. They discovered that the returns of fine art have been significantly overestimated and the risks underestimated by those who stand to gain of positioning art as a viable asset class due to selection bias. The bias resulted from returns based on indices built on repeat sales of fairly illiquid assets that are not sold at random. Why did this bias occur? As Thompson observed, the pieces that sell are the ones that increase in value. In other words, the "average" is calculated based on above-average sales, thereby greatly exaggerating the rate of appreciation for the majority of art. The study observes that from a pure financial perspective, passive index investing in paintings is not a viable investment strategy once selection bias is accounted for.

Study author Arthur Koreweg concludes:

In short, buy paintings if you like looking at them. You can hope that your children will sell one or more of them later for a gain — but paintings are primarily aesthetic investments, not financial ones."

Do you think this holds true? Would you be dissuaded from buying art if you thought it would never appreciate?