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Dynamic Portfolio Selection: the Relevance of Switching Regimes and Investment Horizon

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  • Andreas Graflund
  • Birger Nilsson

Abstract

This paper investigates the questions of dynamic portfolio selection and intertemporal hedging within a Markovian regime-switching framework. The investment opportunity set is spanned by a well-diversified home-market portfolio and the risk-free asset. Our results highlight the economic importance of regimes, as optimal portfolio weights are clearly dependent on the prevailing regime. We present evidence that the question of intertemporal hedging is a more complex issue than is hinted in the previous literature, since demand for intertemporal hedging is present in some regimes, but not in others. Finally, our findings are qualitatively unchanged across the four largest stock markets in the in the world, the US, Japan, the UK and Germany.

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Bibliographic Info

Article provided by European Financial Management Association in its journal European Financial Management.

Volume (Year): 9 (2003)
Issue (Month): 2 ()
Pages: 179-200

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Handle: RePEc:bla:eufman:v:9:y:2003:i:2:p:179-200

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  1. Andrew Ang & Geert Bekaert, 1999. "International Asset Allocation with Time-Varying Correlations," NBER Working Papers 7056, National Bureau of Economic Research, Inc.
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  6. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262112388, December.
  7. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, Econometric Society, vol. 41(5), pages 867-87, September.
  8. Kim, C-J., 1991. "Dynamic Linear Models with Markov-Switching," Papers, York (Canada) - Department of Economics 91-8, York (Canada) - Department of Economics.
  9. Rydén, Tobias & Teräsvirta, Timo & Åsbrink, Stefan, 1996. "Stylized Facts of Daily Return Series and the Hidden Markov Model," Working Paper Series in Economics and Finance 117, Stockholm School of Economics.
  10. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198296942, October.
  11. Brennan, Michael J. & Schwartz, Eduardo S. & Lagnado, Ronald, 1997. "Strategic asset allocation," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 21(8-9), pages 1377-1403, June.
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Cited by:
  1. Bulla, Jan & Mergner, Sascha & Bulla, Ingo & Sesboüé, André & Chesneau, Christophe, 2010. "Markov-switching Asset Allocation: Do Profitable Strategies Exist?," MPRA Paper 21154, University Library of Munich, Germany.
  2. McCarthy, David & Miles, David K, 2007. "Optimal Portfolio Allocation for Corporate Pension Funds," CEPR Discussion Papers 6394, C.E.P.R. Discussion Papers.
  3. Manuel Ammann & Michael Verhofen, 2006. "The Effect of Market Regimes on Style Allocation," Financial Markets and Portfolio Management, Springer, Springer, vol. 20(3), pages 309-337, September.
  4. Kung, James J., 2009. "A two-asset stochastic model for long-term portfolio selection," Mathematics and Computers in Simulation (MATCOM), Elsevier, Elsevier, vol. 79(10), pages 3089-3098.
  5. Kole, Erik & Koedijk, Kees & Verbeek, Marno, 2006. "Portfolio implications of systemic crises," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2347-2369, August.
  6. Kole, H.J.W.G. & Koedijk, C.G. & Verbeek, M.J.C.M., 2004. "The effects of systemic crises when investors can be crisis ignorant," ERIM Report Series Research in Management, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasm ERS-2004-027-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.

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