The Effect of Market Regimes on Style Allocation
University of St. Gallen - Swiss Institute of Banking and Finance
Allianz Global Investors; University of St. Gallen - Swiss Institute of Banking and Finance
January 1, 2009
We analyse time-varying risk premia and the implications for portfolio choice. Using Markov Chain Monte Carlo (MCMC) methods, we estimate a multivariate regime-switching model for the Carhart (1997) four-factor model. We find two clearly separable regimes with different mean returns, volatilities and correlations. In the High-Variance Regime, only value stocks deliver a good performance, whereas in the Low-Variance Regime, the market portfolio and momentum stocks promise high returns. Regime-switching induces investors to change their portfolio style over time depending on the investment horizon, the risk aversion, and the prevailing regime. Value investing seems to be a rational strategy in the High-Variance Regime, momentum investing in the Low-Variance Regime. An empirical out-of-sample backtest indicates that this switching strategy can be profitable, but the overall forecasting ability for the regime-switching model seems to be weak compared to the iid model.
Number of Pages in PDF File: 45
Keywords: Regime Switching, Style Investing, Markov Chain Monte Carlo, Tactical Asset Allocation
JEL Classification: G11, G12, G14working papers series
Date posted: January 23, 2009
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo4 in 0.391 seconds