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Portfolio management under sudden changes in volatility and heterogeneous investment horizons

  • Fernandez, Viviana
  • Lucey, Brian M.

We analyze the implications for portfolio management of accounting for conditional heteroskedasticity and sudden changes in volatility, based on a sample of weekly data of the Dow Jones Country Titans, the CBT-municipal bond, spot and futures prices of commodities for the period 1992–2005. To that end, we first proceed to utilize the ICSS algorithm to detect long-term volatility shifts, and incorporate that information into PGARCH models fitted to the returns series. At the next stage, we simulate returns series and compute a wavelet-based value at risk, which takes into consideration the investor's time horizon. We repeat the same procedure for artificial data generated from semi-parametric estimates of the distribution functions of returns, which account for fat tails. Our estimation results show that neglecting GARCH effects and volatility shifts may lead to an overestimation of financial risk at different time horizons. In addition, we conclude that investors benefit from holding commodities as their low or even negative correlation with stock and bond indices contribute to portfolio diversification.

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File URL: http://www.sciencedirect.com/science/article/pii/S0378437106010454
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Article provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.

Volume (Year): 375 (2007)
Issue (Month): 2 ()
Pages: 612-624

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Handle: RePEc:eee:phsmap:v:375:y:2007:i:2:p:612-624
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