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Regime shifts in mean-variance efficient frontiers: some international evidence

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  • Massimo Guidolin
  • Federica Ria

Abstract

Regime switching models have been assuming an increasingly central role in financial applications because of their well-known ability to capture the presence of rich non-linear patterns in the joint distribution of asset returns. After reviewing key concepts and technical issues related to specifying, estimating, and using multivariate Markov switching models in financial applications, in this paper we examine how the presence of regimes in means, variances, and covariances of asset returns translates into explicit dynamics of the Markowitz mean-variance frontier. In particular, we show both theoretically and through an application to international equity portfolio diversification that substantial differences exist between bull and bear regime-specific frontiers, both in statistical and in economic terms. Using Morgan Stanley Capital International (MSCI) investable indices for five countries/macro-regions, we characterize mean-variance frontiers and optimal portfolio strategies in bull periods, in bear periods, and in periods where high uncertainty exists on the nature of the current regime.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2010-040.

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Date of creation: 2010
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Handle: RePEc:fip:fedlwp:2010-040

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Keywords: Asset pricing ; Econometric models ; Rate of return ; Great Britain;

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References

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  8. Massimo Guidolin & Giovanna Nicodano, 2005. "Small Caps in International Equity Portfolios: The Effects of Variance Risk," CeRP Working Papers 41, Center for Research on Pensions and Welfare Policies, Turin (Italy).
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Cited by:
  1. Turtle, H.J. & Zhang, Chengping, 2012. "Time-varying performance of international mutual funds," Journal of Empirical Finance, Elsevier, vol. 19(3), pages 334-348.
  2. Apostolos Thomadakis, 2012. "Contagion or Flight-to-Quality Phenomena in Stock and Bond Returns," School of Economics Discussion Papers 0612, School of Economics, University of Surrey.

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