Markowitz versus Regime Switching: An Empirical Approach
This article discusses an adjusted regime switching model in the context of portfolio optimization and compares the attained portfolio weights and the performance to a classical mean-variance set-up as introduced by Markowitz (1952). The model postulates different asset price dynamics under different regimes, and jumps between regimes are driven by a Markov process. For examples, 'bear' and 'bull' markets could be such regimes. Given a particular regime, portfolio weights are set based on the conditional means and variancecovariance structure of the asset dynamics. The model is evaluated in an out-of-sample period of the last three years with a moving window and a forecast of only one period. It is found that with the adjusted regime switching portfolio selection algorithm as applied here, the performance of the optimal portfolio is highly improved even where portfolio weights are constrained to realistic values.
Volume (Year): 04 (2012)
Issue (Month): 1 (June)
|Contact details of provider:|| Postal: Strada Mihai Eminescu nr.13-15, sector 1, Bucuresti, Romania|
Web page: http://www.fin.ase.ro/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Goldfeld, Stephen M. & Quandt, Richard E., 1973. "A Markov model for switching regressions," Journal of Econometrics, Elsevier, vol. 1(1), pages 3-15, March.
- Campbell, Rachel & Koedijk, Kees & Kofman, Paul, 2002. "Increased Correlation in Bear markets: A Downside Risk Perspective," CEPR Discussion Papers 3172, C.E.P.R. Discussion Papers.
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1137-1187.
- Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," The Journal of Business, University of Chicago Press, vol. 36, pages 394.
- Levy, Haim, 1969. "A Utility Function Depending on the First Three Moments: Comment," Journal of Finance, American Finance Association, vol. 24(4), pages 715-19, September.
- Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
- Denis Pelletier, 2004.
"Regime Switching for Dynamic Correlations,"
Econometric Society 2004 North American Summer Meetings
230, Econometric Society.
- Andrew Ang & Geert Bekaert, 1998.
"Regime Switches in Interest Rates,"
NBER Working Papers
6508, National Bureau of Economic Research, Inc.
- Frauendorfer, Karl & Jacoby, Ulrich & Schwendener, Alvin, 2007. "Regime switching based portfolio selection for pension funds," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2265-2280, August.
When requesting a correction, please mention this item's handle: RePEc:rfb:journl:v:04:y:2012:i:1:p:033-043. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Tatu Lucian)
If references are entirely missing, you can add them using this form.