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Cross‐region and cross‐sector asset allocation with regimes
Author(s) -
Dou Paul Y.,
Gallagher David R.,
Schneider David,
Walter Terry S.
Publication year - 2014
Publication title -
accounting and finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.645
H-Index - 49
eISSN - 1467-629X
pISSN - 0810-5391
DOI - 10.1111/acfi.12017
Subject(s) - asset allocation , equity (law) , diversification (marketing strategy) , economics , salient , portfolio allocation , portfolio , variance (accounting) , econometrics , financial economics , capital asset pricing model , business , accounting , marketing , political science , law , artificial intelligence , computer science
Cross‐region and cross‐sector asset allocation decisions are one of the most fundamental issues in international equity portfolio management. Equity returns exhibit higher volatilities and correlations, and lower expected returns, in bear markets compared to bull markets. However, static mean–variance analysis fails to capture this salient feature of equity returns. We accommodate the nonlinearity of returns using a regime switching model across both regions and sectors. The regime‐dependent asset allocation potentially adds value to the traditional static mean–variance allocation. In addition, optimal allocation across sectors provide greater benefits compared to international diversification, which is characterized by higher returns, lower risks, lower correlations with the world market and a higher S harpe ratio.