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International asset allocation using the market implied cost of capital

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  • Patrick Bielstein

    (Technical University of Munich)

Abstract

The Black and Litterman (Financ Anal J 48(5):28–43, 1992) (BL) approach to portfolio optimization requires investor views on expected asset returns as an input. I demonstrate that the market implied cost of capital (ICC) is ideal for quantifying those views on a country level. I benchmark this approach against a BL optimization using time-series models as investor views, the equally weighted portfolio, and allocation methods based on stock market capitalization and GDP. I find that the ICC portfolio offers an increase in average return of 2.1 percentage points (yearly) as compared to the value-weighted portfolio, while having a similar standard deviation. The resulting difference in Sharpe ratios is statistically significant and robust to the inclusion of transaction costs, varying BL parameters, and a less strictly defined investment universe.

Suggested Citation

  • Patrick Bielstein, 2018. "International asset allocation using the market implied cost of capital," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 32(1), pages 17-51, February.
    • Handle: RePEc:kap:fmktpm:v:32:y:2018:i:1:d:10.1007_s11408-017-0302-3
    DOI: 10.1007/s11408-017-0302-3
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    More about this item

    Keywords

    International asset allocation; Black–Litterman optimization; Implied cost of capital;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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