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A Risk Management Approach to Optimal Asset Allocation

Author

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  • Thomas J. Flavin

    (Economics, National University of Ireland, Maynooth)

  • Michael R. Wickens

    (University of York, UK.)

Abstract

This paper extends the tactical asset allocation strategy of Flavin and Wickens(1998) to incorporate the effects of macroeconomic variables in the analysis. Using a VAR in mean with a M-GARCH error structure, we can jointly model financial asset returns and macroeconomic variables, thereby exploiting any predictability in either the first- or second-order moments. Taking a set of UK\ financial assets and the change in domestic inflation as an illustration, we find a much stronger impact on the conditional second order moments of the process than on the level of the excess return on financial assets. Taking the inflation effect into account generates portfolio frontiers that in general lie closer to the origin and therefore offer superior risk-return combinations to the investor.

Suggested Citation

  • Thomas J. Flavin & Michael R. Wickens, 2001. "A Risk Management Approach to Optimal Asset Allocation," Economics Department Working Paper Series n1080301, Department of Economics, National University of Ireland - Maynooth.
    • Handle: RePEc:may:mayecw:n1080301
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    Cited by:

    1. Thomas J. Flavin & Michael R. Wickens, 1998. "Optimal International Asset Allocation and Home Bias," Economics Department Working Paper Series n841298, Department of Economics, National University of Ireland - Maynooth.
    2. T.J. Flavin & M.R. Wickens, 2003. "Macroeconomic influences on optimal asset allocation," Review of Financial Economics, John Wiley & Sons, vol. 12(2), pages 207-231.
    3. Thomas J. Flavin & Michael R. Wickens, 1998. ": A Risk Management Approach to Optimal Asset Allocation," Economics Department Working Paper Series n851298, Department of Economics, National University of Ireland - Maynooth.
    4. Andrew Clark, 2005. "The use of Hurst and effective return in investing," Quantitative Finance, Taylor & Francis Journals, vol. 5(1), pages 1-8.
    5. Thomas J. Flavin & Michael R. Wickens, 2006. "Optimal International Asset Allocation With Time‐Varying Risk," Scottish Journal of Political Economy, Scottish Economic Society, vol. 53(5), pages 543-564, November.
    6. Hiona Balfoussia & Mike Wickens, 2007. "Macroeconomic Sources of Risk in the Term Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(1), pages 205-236, February.
    7. Peter Smith & Michael Wickens, 2002. "Asset Pricing with Observable Stochastic Discount Factors," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 397-446, July.
    8. Thomas J. Flavin & Michael R. Wickens, 2000. "Global Asset Allocation with Time-varying Risk," Economics Department Working Paper Series n1020800, Department of Economics, National University of Ireland - Maynooth.
    9. Thomas J. Flavin & Michele G. Limosani, 2000. "Explaining European Short-term Interest Rate Differentials: An Application of Tobin's Portfolio Theory," Economics Department Working Paper Series n1000500, Department of Economics, National University of Ireland - Maynooth.

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    More about this item

    Keywords

    Asset allocation; macroeconomic effects; M-GARCH;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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