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Market timing under multiple economic regimes
Author(s) -
Guido Ron,
Pearl Joshua,
Walsh Kathleen
Publication year - 2011
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/j.1467-629x.2010.00389.x
Subject(s) - economics , business cycle , equity (law) , econometrics , ex ante , asset allocation , risk premium , capital asset pricing model , equity premium puzzle , asset (computer security) , dimension (graph theory) , financial economics , portfolio , macroeconomics , computer science , mathematics , political science , law , computer security , pure mathematics
This article models the US equity premium as a regime‐switching process where the regimes are dependent on economic variables. To characterise the economic regimes, we employ the dimension reduction technique of a principal components analysis to extract business cycle signals from a set of observed macroeconomic variables. We use these conditioning agents to infer the ex ante economic regime. We then test a dynamic asset allocation strategy, which invests in equity and cash on the basis of the predicted regimes. This timing strategy is shown to outperform a simple buy and hold strategy on a risk‐adjusted basis.