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Cross-region and cross-sector asset allocation with regimes

Author

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  • Paul Y. Dou
  • David R. Gallagher
  • David Schneider
  • Terry S. Walter
  • Henk Berkman

Abstract

type="main" xml:id="acfi12017-abs-0001"> Cross-region and cross-sector asset allocation decisions are one of the most fundamental issues in international equity portfolio management. Equity returns exhibit higher volatilities and correlations, and lower expected returns, in bear markets compared to bull markets. However, static mean–variance analysis fails to capture this salient feature of equity returns. We accommodate the nonlinearity of returns using a regime switching model across both regions and sectors. The regime-dependent asset allocation potentially adds value to the traditional static mean–variance allocation. In addition, optimal allocation across sectors provide greater benefits compared to international diversification, which is characterized by higher returns, lower risks, lower correlations with the world market and a higher Sharpe ratio.

Suggested Citation

  • Paul Y. Dou & David R. Gallagher & David Schneider & Terry S. Walter & Henk Berkman, 2014. "Cross-region and cross-sector asset allocation with regimes," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 54(3), pages 809-846, September.
    • Handle: RePEc:bla:acctfi:v:54:y:2014:i:3:p:809-846
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    File URL: http://hdl.handle.net/10.1111/acfi.2014.54.issue-3
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    Cited by:

    1. Hematizadeh, Roksana & Tajaddini, Reza & Hallahan, Terrence, 2022. "Dynamic asset allocation strategy using a state-dependent Markov model: Applications to international equity markets," Journal of International Money and Finance, Elsevier, vol. 128(C).
    2. Constantinos Alexiou & Anshul Tyagi, 2020. "Gauging the effectiveness of sector rotation strategies: evidence from the USA and Europe," Journal of Asset Management, Palgrave Macmillan, vol. 21(3), pages 239-260, May.
    3. Golam Sarwar & Cesario Mateus & Natasa Todorovic, 2018. "US sector rotation with five-factor Fama–French alphas," Journal of Asset Management, Palgrave Macmillan, vol. 19(2), pages 116-132, March.
    4. Lee, Eun-Joo, 2017. "Intra- and inter-regional portfolio diversification strategies under regional market integration: Evidence from U.S. global banks," International Review of Financial Analysis, Elsevier, vol. 54(C), pages 1-22.
    5. Laura Arenas & Ana Maria Gil-Lafuente, 2021. "Regime Switching in High-Tech ETFs: Idiosyncratic Volatility and Return," Mathematics, MDPI, vol. 9(7), pages 1-25, March.

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