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: A Risk Management Approach to Optimal Asset Allocation

  • Thomas J. Flavin

    ()

    (Economics, National University of Ireland, Maynooth)

  • Michael R. Wickens

    (University of York, UK.)

This paper examines how to improve tactical asset allocation by better risk management instead of concentrating on maximising returns. This is achieved by using forecasts of the time- varying conditional covariance matrix of returns obtained from a new specification of the multivariate GARCH process that is particularly well suited to modelling asset returns due to its generality, parameter parsimony and relative ease of estimation. We show that for a portfolio of four UK assets over the period 1976-1997 it would be possible to reduce portfolio risk by on average 5% compared with using the constant sample covariance matrix.

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File URL: http://repec.maynoothuniversity.ie/mayecw-files/N841298.pdf
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Paper provided by Department of Economics, Finance and Accounting, National University of Ireland - Maynooth in its series Economics, Finance and Accounting Department Working Paper Series with number n851298.

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Length: 30 pages
Date of creation: Dec 1998
Date of revision:
Handle: RePEc:may:mayecw:n851298
Contact details of provider: Postal: Maynooth, Co. Kildare
Phone: 353-1-7083728
Fax: 353-1-7083934
Web page: http://www.maynoothuniversity.ie/economics-finance-and-accounting

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  1. Engel, Charles & Rodrigues, Anthony P, 1989. "Tests of International CAPM with Time-Varying Covariances," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 4(2), pages 119-38, April-Jun.
  2. Thomas J. Flavin & Michael R. Wickens, 1998. ": A Risk Management Approach to Optimal Asset Allocation," Economics, Finance and Accounting Department Working Paper Series n851298, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  3. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
  4. John Y. Campbell & Robert J. Shiller, 1989. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," NBER Working Papers 3153, National Bureau of Economic Research, Inc.
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  6. Clare, A D & Thomas, S H & Wickens, M R, 1994. "Is the Gilt-Equity Yield Ratio Useful for Predicting UK Stock Returns?," Economic Journal, Royal Economic Society, vol. 104(423), pages 303-15, March.
  7. Campbell, John Y & Ammer, John, 1993. " What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns," Journal of Finance, American Finance Association, vol. 48(1), pages 3-37, March.
  8. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-57, March.
  9. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, vol. 44(5), pages 1115-53, December.
  10. Nicolaas Groenewold & Gregory O'Rourke & Stephen Thomas, 1997. "Stock returns and inflation: a macro analysis," Applied Financial Economics, Taylor & Francis Journals, vol. 7(2), pages 127-136.
  11. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
  12. Smith, Peter N & Wickens, Michael R., 2002. "Macroeconomic Sources of FOREX Risk," CEPR Discussion Papers 3148, C.E.P.R. Discussion Papers.
  13. Tzavalis, Elias & Wickens, Michael R, 1997. "Explaining the Failures of the Term Spread Models of the Rational Expectations Hypothesis of the Term Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 364-80, August.
  14. Fama, Eugene F & French, Kenneth R, 1995. " Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-55, March.
  15. repec:cup:etheor:v:11:y:1995:i:1:p:122-50 is not listed on IDEAS
  16. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
  17. John Y. Campbell, 1985. "Stock Returns and the Term Structure," NBER Working Papers 1626, National Bureau of Economic Research, Inc.
  18. Andrew Clare & Raymond O'Brien & Stephen Thomas & Michael Wickens, . "Macroeconomic Shocks and the Domestic CAPM: Evidence from the UK Stock Market," Discussion Papers 94/10, Department of Economics, University of York.
  19. Wayne E. Ferson & Campbell R. Harvey, 1996. "Fundamental Determinants of National Equity Market Returns: A Perspective on Conditional Asset Pricing," NBER Working Papers 5860, National Bureau of Economic Research, Inc.
  20. Yacine AÏT-SAHALIA, & Michael W. BRANDT, 2001. "Variable Selection for Portfolio Choice," FAME Research Paper Series rp34, International Center for Financial Asset Management and Engineering.
  21. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December.
  22. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
  23. Karen K. Lewis, 1998. "International Home Bias in International Finance and Business Cycles," NBER Working Papers 6351, National Bureau of Economic Research, Inc.
  24. Levy, Haim & Sarnat, Marshall, 1970. "International Diversification of Investment Portfolios," American Economic Review, American Economic Association, vol. 60(4), pages 668-75, September.
  25. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
  26. French, Kenneth R & Poterba, James M, 1991. "Investor Diversification and International Equity Markets," American Economic Review, American Economic Association, vol. 81(2), pages 222-26, May.
  27. Bollerslev, Tim & Engle, Robert F. & Nelson, Daniel B., 1986. "Arch models," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 49, pages 2959-3038 Elsevier.
  28. Cumby, Robert & Figlewski, Stephen & Hasbrouck, Joel, 1994. "International asset allocation with time varying risk: an analysis and implementation," Japan and the World Economy, Elsevier, vol. 6(1), pages 1-25.
  29. Jorion, Philippe, 1985. "International Portfolio Diversification with Estimation Risk," The Journal of Business, University of Chicago Press, vol. 58(3), pages 259-78, July.
  30. Thomas J. Flavin & Michael R. Wickens, 2000. "Global Asset Allocation with Time-varying Risk," Economics, Finance and Accounting Department Working Paper Series n1020800, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  31. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  32. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
  33. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
  34. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
  35. Cooper, Ian & Kaplanis, Evi, 1994. "Home Bias in Equity Portfolios, Inflation Hedging, and International Capital Market Equilibrium," Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 45-60.
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