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International Asset Allocation with Time-Varying Correlations

80 Pages Posted: 7 Apr 1999  

Geert Bekaert

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Andrew Ang

BlackRock, Inc

Multiple version iconThere are 2 versions of this paper

Date Written: March 12, 1999

Abstract

It is widely believed that correlations between international equity markets tend to increase in highly volatile bear markets. This has led some to doubt the benefits of international diversification. This article solves the dynamic portfolio choice problem of a US investor faced with a time-varying investment opportunity set which may be characterized by correlations and volatilities that increase in bad times. We model the state dependence of US, UK and German equity returns using a regime-switching model and find evidence for the existence of a high volatility regime, in which returns are more highly correlated and have lower means. Solving the dynamic asset allocation problem for a CRRA investor, we show international diversification is still valuable with regime changes. Currency hedging imparts further benefit. The costs of ignoring the regimes are small for moderate levels of risk aversion, and the intertemporal hedging demands induced by time-varying correlations are negligible.

JEL Classification: C12, C13, C32, E32, F30, G11

Suggested Citation

Bekaert, Geert and Ang, Andrew, International Asset Allocation with Time-Varying Correlations (March 12, 1999). Available at SSRN: https://ssrn.com/abstract=156048 or http://dx.doi.org/10.2139/ssrn.156048

Geert Bekaert

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

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