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Macroeconomic influences on optimal asset allocation

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  • Flavin, T. J.
  • Wickens, M. R.

Abstract

We develop a tactical asset allocation strategy that incorporates the effects of macroeconomic variables. The joint distribution of financial asset returns and the macroeconomic variables is modelled using a VAR with a multivariate GARCH (M‐GARCH) error structure. As a result, the portfolio frontier is time varying and subject to contagion from the macroeconomic variable. Optimal asset allocation requires that this be taken into account. We illustrate how to do this using three risky UK assets and inflation as a macroeconomic factor. Taking account of inflation generates portfolio frontiers that lie closer to the origin and offers investors superior risk–return combinations.
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  • Flavin, T. J. & Wickens, M. R., 2003. "Macroeconomic influences on optimal asset allocation," Review of Financial Economics, Elsevier, vol. 12(2), pages 207-231.
    • Handle: RePEc:eee:revfin:v:12:y:2003:i:2:p:207-231
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    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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