Strategic Asset Allocation and the Role of Alternative Investments
43 Pages Posted: 20 Mar 2008 Last revised: 14 May 2011
This paper introduces a new framework for strategic asset allocation with alternative investments (buyouts, commodities, hedge funds, REITs, and venture capital). Our approach is not based on a utility function, but on an easily quantifiable risk preference parameter, λ. We account for higher moments of the return distributions within our optimization framework and approximate best-fit distributions. Thus, we replace the empirical return distributions, which are often skewed and/or exhibit excess kurtosis, with two normal distributions. We then use the estimated return distributions in the strategic asset allocation. Our results show in various out-of-sample analyses that our framework yields superior results compared to the Markowitz framework. Furthermore, our framework better manages regime switches, which tend to occur frequently during crises. To test our results for stability and robustness, we use, among other things time-varying correlation structures in the return distributions and weight restrictions for the asset classes.
Keywords: Alternative Investments, Asset Allocation, Asset Backed Securities, Buy Out, Commodities, Hedge Fund, Higher Moments, Private Equity, REITs, Venture Capital
JEL Classification: G2, G12, G31
Suggested Citation: Suggested Citation