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Mixed Tactical Asset Allocation

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  • Alejandro Corvalán

Abstract

In a typical tactical asset allocation set up a manager receives compensation for his excess of return given a tracking error target. Critics of this framework cite its lack of control over the total portfolio risk. Current approaches recommend what we call a mixed allocation, derived from concerns about relative and absolute return and risk. This work provides an analytical framework for mixed tactical asset allocation, based on the premise that after the investor sets a tracking error target, a fundamental trade off remains unsolved: the one between excess of return and total risk. The article derives a separation theorem for tactical allocation, wherein the portfolio is a linear combination of an alpha portfolio providing excess returns and a beta portfolio providing overall risk hedge. The author shows how the formal expression summarizes all previous works. Moreover, it also includes the simplest Black-Litterman allocation.

Suggested Citation

  • Alejandro Corvalán, 2005. "Mixed Tactical Asset Allocation," Working Papers Central Bank of Chile 323, Central Bank of Chile.
    • Handle: RePEc:chb:bcchwp:323
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    File URL: https://www.bcentral.cl/documents/33528/133326/DTBC_323.pdf
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    References listed on IDEAS

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    3. Best, Michael J & Grauer, Robert R, 1985. "Capital Asset Pricing Compatible with Observed Market Value Weights," Journal of Finance, American Finance Association, vol. 40(1), pages 85-103, March.
    4. Sharpe, W F, 1981. "Decentralized Investment Management," Journal of Finance, American Finance Association, vol. 36(2), pages 217-234, May.
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