Dynamic Strategic Asset Allocation: Risk and Return Across Economic Regimes
25 Pages Posted: 19 Feb 2009 Last revised: 17 Jul 2009
Date Written: July 2009
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.
Keywords: asset allocation, TAA, economic regimes, business cycle, portfolio choice, time-varying risk, time-varying return
JEL Classification: C32, G11, C11
Suggested Citation: Suggested Citation