International Asset Allocation Under Regime Switching, Skew and Kurtosis Preferences
By Massimo Guidolin, Allan G. Timmermann. 2005
432 citations recorded by the source corpus.
This paper proposes a new tractable approach to solving asset allocation problems in situations with a large number of risky assets which pose problems for standard approaches. Investor preferences are assumed to be defined over moments of the wealth distribution such as its mean, variance, skew and kurtosis. Time-variations in investment opportunities are represented by a flexible regime switching process. In the context of a four-moment international CAPM specification that relates stock returns in five regions to returns on a global market portfolio, we find evidence of distinct bull and bear states. Ignoring regimes, an unhedged US investor’s optimal portfolio is strongly diversified internationally. The presence of regimes in the return distribution leads to a large increase in the investor’s optimal holdings of US stocks as does the introduction of skew and kurtosis preferences. Our paper therefore offers an explanation of the strong home bias observed in US investors’ asset allocation based on regime switching and skew and kurtosis preferences.
Subfields: Finance
View Paper: https://www.semanticscholar.org/paper/da4893cf357751a6ed8fdbe43cb4d87981f663eb
How researchers see this paper
The researchers whose trusted networks rank it highest, strongest advocate first. Every researcher gets a different order.
In Finance
- Massimo Guidolin
- Allan G. Timmermann
- Geert Bekaert
- Campbell R. Harvey
- Andrew Ang
- Raman Uppal
- Grigory Vilkov
- Gurdip Bakshi
Citations in the corpus
- Market Integration and Contagion (2005, positive): “Ang and Bekaert (2002) report that GARCH models (although simpler than the ones we study here) do not capture asymmetric correlations very well and propose a regime switching model. that result from an asset pricing model, before making statements about contagion.”
- Improving Portfolio Selection Using Option-Implied Volatility and Skewness (2013, background): “The time-variations in risk premia, volatility, correlations, skewness, kurtosis, co-skewness and co-kurtosis measured directly from stock returns, see Guidolin and Timmermann (2008).”
- The Baltic Dry Index as a Predictor of Global Stock Returns, Commodity Returns, and Global Economic Activity (2010, methodology): “Thus, our empirical analysis is conducted from the viewpoint of US-based investors (e.g., Harvey (1991), De Santis and Gerard (1997), Guidolin and Timmermann (2008), Bekaert, Hodrick, and Zhang (2009), and Pakthuanthong and Roll (2009)).”
- A New Class of Tests of Contagion With Applications (2008, methodology): “A natural generalization of (18) which allows for higher order moments is given by the following bivariate generalized normal distribution with M = 6 in (15)”
- Regime Changes and Financial Markets (2012, background): “Guidolin and Timmermann (2008c) consider asset allocation over international assets with a regime switching model by an investor who takes into account skew and kurtosis preferences.”
- Modeling International Financial Returns with a Multivariate Regime Switching Copula (2009, neutral): “Regime-switching models were introduced in econometrics by Hamilton (1989) and have since been widely applied in finance. For instance Ang & Bekaert (2002b), Guidolin & Timmermann (2006a) and Guidolin & Timmermann (2006b) use regime-switching models for interest rates. Ang & Bekaert (2002a) and Guid”
- Asset Allocation Under Multivariate Regime Switching (2005, methodology): “15Detailed results are available in Guidolin and Timmermann (2005a).”