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Asymmetric Risk and International Portfolio Choice

Author

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  • Susan Thorp
  • George Milunovich

    (Division of Economic and Financial Studies, Macquarie University)

Abstract

Empirical research shows that stock volatilities and correlations between markets rise more after negative shocks than after positive returns shocks of the same size. We measure the importance of these asymmetric effects for mean-variance investors holding portfolios of international equities who use dynamic conditional covariance forecasts to reweight their portfolios. Portfolio weights are computed using ex ante predictions from symmetric GARCH DCC and asymmetric GJR ADCC models, and a spectrum of expected returns. Data are weekly returns to equity price indices for the USA, Japan, UK and Australia. We find that the majority of realised portfolio standard deviations are less when we reweight using the asymmetric covariance model. Reductions in portfolio risk are significant according to Diebold-Mariano tests. Investors who are moderately risk averse and have longer rebalancing horizons benefit more from the asymmetric model than less risk averse, shorter-horizon investors, and would be prepared to pay up to 107 basis points annually to use it instead of the symmetric model. Benefits are greater for investors holding US equities.

Suggested Citation

  • Susan Thorp & George Milunovich, 2005. "Asymmetric Risk and International Portfolio Choice," Research Paper Series 160, Quantitative Finance Research Centre, University of Technology, Sydney.
  • Handle: RePEc:uts:rpaper:160
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    File URL: http://www.qfrc.uts.edu.au/research/research_papers/rp160.pdf
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    References listed on IDEAS

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    5. Milunovich, George & Thorp, Susan, 2006. "Valuing volatility spillovers," Global Finance Journal, Elsevier, vol. 17(1), pages 1-22, September.
    6. Sanjiv Ranjan Das & Raman Uppal, 2004. "Systemic Risk and International Portfolio Choice," Journal of Finance, American Finance Association, vol. 59(6), pages 2809-2834, December.
    7. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
    8. Wu, Guojun, 2001. "The Determinants of Asymmetric Volatility," Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 837-859.
    9. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-144, January.
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    12. Kroner, Kenneth F & Ng, Victor K, 1998. "Modeling Asymmetric Comovements of Asset Returns," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 817-844.
    13. Fran├žois Longin, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, April.
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    Cited by:

    1. Zhichao Zhang & Li Ding & Fan Zhang & Zhuang Zhang, 2015. "Optimal Currency Composition for China's Foreign Reserves: A Copula Approach," The World Economy, Wiley Blackwell, vol. 38(12), pages 1947-1965, December.

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