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Abstract:
In this paper we examine global tactical asset allocation (GTAA) strategies across a broad range of asset classes. Contrary to market timing for single asset classes and tactical allocation across similar assets, this topic has received little attention in the existing literature. Our main finding is that momentum and value strategies applied to GTAA across twelve asset classes deliver statistically and economically significant abnormal returns. For a long top-quartile and short bottom-quartile portfolio based on a combination of momentum and value signals we find a return of 12% per annum over the 1986-2007 period. Performance is stable over time, also present in an out-of-sample period and sufficiently high to overcome transaction costs in practice. The return cannot be explained by potential structural biases towards asset classes with high risk premiums, nor the Fama French and Carhart hedge factors. We argue that financial markets may be macro inefficient due to insufficient 'smart money' being available to arbitrage mispricing effects away.

GTAA, value effect, momentum, global asset allocation

Abstract:
In this paper we examine global tactical asset allocation (GTAA) strategies across a broad range of asset classes. Contrary to market timing for single asset classes and tactical allocation across similar assets, this topic has received little attention in the existing literature. Our main finding is that momentum and value strategies applied to GTAA across twelve asset classes deliver statistically and economically significant abnormal returns. For a long top-quartile and short bottom-quartile portfolio based on a combination of momentum and value signals we find a return exceeding 9% per annum over the 1986-2007 period. Performance is stable over time, also present in an out-of-sample period and sufficiently high to overcome transaction costs in practice. The return cannot be explained by implicit beta exposures or the Fama French and Carhart hedge factors. We argue that financial markets may be macro inefficient due to insufficient 'smart money' being available to arbitrage mispricing effects away.

GTAA, Asset Allocation, Tactical Asset Allocation, Momentum, Value, Alpha

Abstract:
We present empirical evidence that stocks with low volatility earn high risk-adjusted returns. The annual alpha spread of global low versus high volatility decile portfolios amounts to 12% over the 1986-2006 period. We also observe this volatility effect within the US, European and Japanese markets in isolation. Furthermore, we find that the volatility effect cannot be explained by other well-known effects such as value and size. Our results indicate that equity investors overpay for risky stocks. Possible explanations for this phenomenon include (i) leverage restrictions, (ii) inefficient two-step investment processes, and (iii) behavioral biases of private investors. In order to exploit the volatility effect in practice we argue that investors should include low risk stocks as a separate asset class in the strategic asset allocation phase of their investment process.

alpha, strategic asset allocation, volatility, volatility effect, low risk stocks, CAPM, Fama-French factors, international

Abstract:
The mean-semivariance CAPM better explains the cross-section of US stock returns than the traditional mean-variance CAPM does. If regular beta is replaced by downside beta, the cross-sectional risk-return relationship improves considerably. Especially during bad-states of the world, when the equity premium is high, we find a near-perfect relation between risk and return. The explanatory power of conditional downside risk remains after controlling for the known size, value and momentum effects.

Asset pricing, downside risk, conditional tests, CAPM, non-linear kernels, asymmetry, semi-variance, lower partial moments

Abstract:
We analyze if the value-weighted stock market portfolio is second-order stochastic dominance (SSD) efficient relative to benchmark portfolios formed on size, value, and momentum. In the process, we also develop several methodological improvements to the existing tests for SSD efficiency. Interestingly, the market portfolio is SSD efficient relative to all benchmark sets. By contrast, the market portfolio is inefficient if we replace the SSD criterion with the traditional mean-variance criterion. Combined these results suggests that the mean-variance inefficiency of the market portfolio is caused by the omission of return moments other than variance. Especially downside risk seems to be important for rationalizing asset pricing puzzles in the 1970s and the early 1980s.

stock market efficiency, asset pricing, SSD, lower partial moments, downside risk

Abstract:
We propose a practical investment framework for dynamic asset allocation across different economic regimes, which we illustrate using a sample of U.S. data from 1948 to 2007. We identify four regimes in the economic cycle and find that these regimes capture pronounced time-variation in the risk and return properties of asset classes. Time-variation is also observed in the risk of a traditional, static strategic asset allocation portfolio. In order to stabilize risk across the economic cycle we propose a dynamic strategic asset allocation approach, which has the potential to enhance expected return as well. The proposed approach is found to be robust to variations in the variable composition of the regime model and can easily be extended with different economic variables and/or additional assets.

asset allocation, TAA, economic regimes, business cycle, portfolio choice, time-varying risk, time-varying return

Abstract:
Empirically, co-skewness of asset returns seems to explain a substantial part of the cross-sectional variation of mean return not explained by beta. Thisfinding is typically interpreted in terms of a risk averse representativeinvestor with a cubic utility function. This comment questions thisinterpretation. We show that the empirical tests fail to impose risk aversionand the implied utility function takes an inverse S-shape. Unfortunately, thefirst-order conditions are not sufficient to guarantee that the market portfoliois the global maximum for an inverse S-shaped utility function, and ourresults suggest that the market portfolio is more likely to represent theglobal minimum than the global maximum. In addition, if we impose riskaversion, then co-skewness has minimal explanatory power.

asset pricing, risk aversion, skewness preference, representative investor, three-moment model

Abstract:
This study compares the single-factor CAPM with the Fama and French three-factor model and the Carhart four-factor model using a broad cross-section and long time-series of US stock portfolios and controlling for market capitalization. Confirming known results, multiple factors help for value and momentum portfolios in the post-1963 period, most notably for the small cap market segment. However, multiple factors generally do not help or even hurt (1) in the pre-1963 period, (2) for size, beta, reversal, and industry portfolios and (3) within the large cap market segment. These empirical findings support the data snooping hypothesis or other non-risk based explanations such as high transaction costs and low market liquidity for small caps.

Fama-French factors, Carhart factor, SMB, HML, WML, efficiency tests

Abstract:
Over the last decade we have witnessed the rise and fall of the so-called new economy stocks. One central question is to what extent these new firms differ from traditional firms. Empirical evidence suggests that stock returns are not normally distributed. In this article we investigate whether this also holds for portfolios of stocks from a growth industry. Furthermore, we will compare this type of portfolios with portfolios of stocks from a more traditional industry. Usually, only value weighted and equally weighted portfolios are used to describe and compare portfolio return characteristics. Instead, in our analysis, we use a novel approach in which we use an infinite number of portfolios that together represent the set of all feasible portfolio opportunities.

Portfolio Management, Investments, Stock Markets, Sector Index, Performance Evaluation

Abstract:
Over the last decade we have witnessed the rise and fall of theso-called new economy stocks. One central question is to what extentthese new firms differ from traditional firms. Empirical evidencesuggests that stock returns are not normally distributed. In thisarticle we investigate whether this also holds for portfolios ofstocks from a growth industry. Furthermore, we will compare this typeof portfolios with portfolios of stocks from a more traditionalindustry. Usually, only value weighted and equally weighted portfoliosare used to describe and compare portfolio return characteristics.Instead, in our analysis, we use a novel approach in which we use aninfinite number of portfolios that together represent the set of allfeasible portfolio opportunities.

portfolio management, investments, stock markets, sector index, performance evaluation

Abstract:
Downside risk, when properly defined and estimated, helps to explain the cross-section of US stock returns. Sorting stocks by a proper estimate of downside market beta leads to a substantially larger cross-sectional spread in average returns than sorting on regular market beta. This result arises despite the fact that downside beta is based on fewer return observations and therefore is more difficult to estimate and predict. The explanatory power of downside risk remains after controlling for other stock characteristics, including firm-level size, value and momentum.

Asset pricing, downside risk, semi-variance, lower partial moments

Abstract:
Downside risk, when properly defined and estimated, helps to explain the cross-section of US stock returns. Sorting stocks by a proper estimate of downside market beta leads to a substantially larger cross-sectional spread in average returns than sorting on regular market beta. This result arises despite the fact that downside beta is based on fewer return observations and therefore is more difficult to estimate and predict. The explanatory power of downside risk remains after controlling for other stock characteristics, including firm-level size, value and momentum.

Asset pricing, downside risk, semi-variance, lower partial moments

Abstract:
The value-weighted stock market portfolio is efficient for loss-averse investors with a substantial exposure to fixed-income instruments such as bills, bonds and loans. Despite the sizeable premium for value stocks, growth stocks are attractive to these investors because they offer a good hedge against fixed-income risk. This finding casts doubt on the practical relevance of the value premium for institutional investors such as life-insurance companies, banks and pension funds who generally invest heavily in fixed-income instruments. Our findings also rekindle hope for a simple representative investor model of capital market equilibrium, provided the represenative investor is loss-averse and the market portfolio is dominated by fixed-income instruments or correlated assets.

Loss aversion, equity premium, value premium, asset pricing

Abstract:
Downside risk, when properly defined and estimated, helps to explain the cross-section of US stock returns. Sorting stocks by a proper estimate of downside market beta leads to a substantially larger cross-sectional spread in average returns than sorting on regular market beta. This result arises despite the fact that downside beta is based on fewer return observations and therefore is more difficult to estimate and predict. The explanatory power of downside risk remains after controlling for other stock characteristics, including firm-level size, value and momentum.

asset pricing, downside risk, semi-variance, lower partial moments

Abstract:
The mean-semivariance CAPM strongly outperforms the traditional mean-variance CAPM in terms of its ability to explain the cross-section of US stock returns. If regular beta is replaced by downside beta, the traditional risk-return relationship is restored. The downside betas of low-beta stocks are substantially higher than the regular betas, while high-beta stocks involve less systematic downside risk than suggested by their regular betas. This pattern is especially pronounced during bad states-of-the-world, when the market risk premium is high. In sum, our results provide evidence in favor of market portfolio efficiency, provided we account for conditional downside risk.

Downside risk, conditional downside risk, CAPM, non-linear kernel, asymmetry, semi-variance, lower partial moments

Abstract:
This study conducts a classroom experiment and an online experiment to examine individual decision-making under risk. Like Levy and Levy (2002), the experiment uses pairs of mixed gambles with moderate probabilities to avoid the framing effect and certainty affect that may affect non-mixed gambles with extreme probabilities. Also, we use Stochastic Dominance criteria to avoid parametric specification of decision-maker preferences. Explicitly accounting for the Wakker (2003) comment, we find several serious violations of Cumulative Prospect Theory (CPT). In fact, in a head-to-head competition between Second-order Stochastic Dominance (SSD) and CPT, most individuals choose the SSD alternative.

Cumulative prospect theory, expected utility, mixed gambles, probability weighting, stochastic dominance

Abstract:
The value premium substantially reduces for downside risk averse investors with a substantial fixed income exposure, such as insurance companies and pension funds. Growth stocks are attractive to these investors because they offer a good hedge against a bad bond performance. This result holds for evaluation horizons of around one year. Our findings cast doubt on the practical relevance of the value premium for such investors and reiterates the importance of the choice of the relevant test portfolio, risk measure and investment horizon in empirical tests of market efficiency and equilibrium.

downside risk, semi-variance, interest rates, fixed income, value premium, asset pricing, behavioral finance, bond returns

Abstract:
We present empirical evidence that stocks with low volatility earn high risk-adjusted returns. The annual alpha spread of global low versus high volatility decile portfolios amounts to 12% over the 1986-2006 period. We also observe this volatility effect within the US, European and Japanese markets in isolation. Furthermore, we find that the volatility effect cannot be explained by other well-known effects such as value and size. Our results indicate that equity investors overpay for risky stocks. Possible explanations for this phenomenon include (i) leverage restrictions, (ii) inefficient two-step investment processes, and (iii) behavioral biases of private investors. In order to exploit the volatility effect in practice we argue that investors should include low risk stocks as a separate asset class in the strategic asset allocation phase of their investment process.

alpha, strategic asset allocation, volatility, volatility effect, low risk stocks, CAPM, Fama-French factors, international