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Portfolio selection under changing market conditions

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  • Cornelia Ernst
  • Martin Grossmann
  • Stephan Hocht
  • Stefan Minden
  • Matthias Scherer
  • Rudi Zagst
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    Abstract

    In this paper, an extensive portfolio optimisation case study is conducted. For this, in a first step, a Markov-Switching model is estimated to time series of three global stock indices. The estimation includes a new methodology for the search for realistic initial values and a large number of covariates that were tested for their ability to explain transition probabilities. In the second step, the model is used in an industry-standard portfolio optimisation environment and compared under realistic assumptions to a Black-Scholes model. The results indicate that risk measures are significantly reduced and performance measures improved when a Markov-Switching model is used. These improvements are especially due to the faster reallocations in turbulent market phases like the burst of the dot-com bubble or the current financial crisis.

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    Bibliographic Info

    Article provided by Inderscience Enterprises Ltd in its journal Int. J. of Financial Services Management.

    Volume (Year): 4 (2009)
    Issue (Month): 1 ()
    Pages: 48-63

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    Handle: RePEc:ids:ijfsmg:v:4:y:2009:i:1:p:48-63

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    Web page: http://www.inderscience.com/browse/index.php?journalID=76

    Related research

    Keywords: Markov switching; portfolio selection; financial crisis; market conditions; portfolio optimisation; performance measures; risk management; turbulent markets.;

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    Cited by:
    1. Johannes Hauptmann & Anja Hoppenkamps & Aleksey Min & Franz Ramsauer & Rudi Zagst, 2014. "Forecasting market turbulence using regime-switching models," Financial Markets and Portfolio Management, Springer, vol. 28(2), pages 139-164, May.

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