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Portfolio selection under changing market conditions

Author

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

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.

Suggested Citation

  • Cornelia Ernst & Martin Grossmann & Stephan Hocht & Stefan Minden & Matthias Scherer & Rudi Zagst, 2009. "Portfolio selection under changing market conditions," International Journal of Financial Services Management, Inderscience Enterprises Ltd, vol. 4(1), pages 48-63.
  • Handle: RePEc:ids:ijfsmg:v:4:y:2009:i:1:p:48-63
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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;Swiss Society for Financial Market Research, vol. 28(2), pages 139-164, May.

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