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A Dynamic, Globally Diversified, Index Neutral Synthetic Asset Allocation Strategy

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  • Frederick Novomestky

    (Management Department, Polytechnic University, Brooklyn, New York 11201)

Abstract

An investor with the ability to assess the prospective return and risk structure of the global capital markets can construct portfolios that, over time, will not only outperform actively or passively managed domestic asset portfolios but will also outperform passively managed global portfolios. A Bayesian approach to dynamic seemingly unrelated regression (DSUR) is a robust and effective means to forecast the one-step ahead, conditional distribution of asset returns. This approach recognizes the time-varying nature of the global capital markets. The predictive moments are used to derive a single-factor return model once an index portfolio is specified. The index portfolio represents an investor's underlying portfolio. Given the factor model that assesses the relative attractiveness and risk of the assets in relation to the index, an index neutral portfolio is constructed as an overlay to enhance the returns of the index portfolio. This portfolio is mean-variance optimal, is notional neutral (i.e., the sum of the asset exposures is zero), and has returns that are designed to be uncorrelated with the returns of the index portfolio. The implementation of such an index neutral portfolio using derivative securities is simulated over the period January 1988 to December 1993.

Suggested Citation

  • Frederick Novomestky, 1997. "A Dynamic, Globally Diversified, Index Neutral Synthetic Asset Allocation Strategy," Management Science, INFORMS, vol. 43(7), pages 998-1016, July.
    • Handle: RePEc:inm:ormnsc:v:43:y:1997:i:7:p:998-1016
    DOI: 10.1287/mnsc.43.7.998
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    Cited by:

    1. Chiou, Wan-Jiun Paul, 2008. "Who benefits more from international diversification?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 18(5), pages 466-482, December.
    2. Wan- Jiun Paul Chiou & Chun- Pin Hsu & Chin- Wen Huang, 2013. "Development and international diversification benefits of equity markets in China, Hong Kong, and Taiwan," Chapters, in: Peter C.Y. Chow (ed.), Economic Integration Across the Taiwan Strait, chapter 5, pages 102-138, Edward Elgar Publishing.
    3. Chiou, Wan-Jiun Paul & Lee, Alice C. & Chang, Chiu-Chi A., 2009. "Do investors still benefit from international diversification with investment constraints?," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(2), pages 448-483, May.
    4. Paul Chiou & Cheng-Few Lee, 2013. "Do investors still benefit from culturally home-biased diversification? An empirical study of China, Hong Kong, and Taiwan," Review of Quantitative Finance and Accounting, Springer, vol. 40(2), pages 341-381, February.
    5. Chiou, Wan-Jiun Paul, 2009. "Benefits of international diversification with investment constraints: An over-time perspective," Journal of Multinational Financial Management, Elsevier, vol. 19(2), pages 93-110, April.

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