Regime Switching, Asymmetric Correlation and International Portfolio Choices

20 Pages Posted: 10 Mar 2010

See all articles by Fathi Abid

Fathi Abid

University of Sfax, Faculty of Economic and Management Sciences, Probability & Statistics Laboratory

Slah Bahloul

University of Sfax - Higher Institute of Business Administration

Date Written: January 2010

Abstract

The aim of this paper is to investigate the behavior of international equity returns and correlations using the discrete-time Markov-switching model and the impact of this behavior on international portfolio choices. We take the perspective of a US-based global investor who considers investment across the six largest major markets over the period from December 1994 to July 2009. Results show that financial markets are characterized by two regimes: a bull and a bear markets. Besides, correlations appear to be very important in a bear state and significantly different than those in bull market. Finally, optimal portfolio weights vary considerably across regimes and over time as investors revise their estimates of the state probabilities. For a degree of risk aversion equal to three, the optimal weight of domestic asset is equal to 100% in a bear regime. Thus, the presence of regime in the equity return distributions turns out to play important roles in the U.S. investors’ international portfolio choices. Therefore, it helps to explain the home equity bias.

Keywords: Markov regime switching, asymmetric correlation, portfolio optimization, international portfolio choices

JEL Classification: F3, G11, G15

Suggested Citation

Abid, Fathi and Bahloul, Slah, Regime Switching, Asymmetric Correlation and International Portfolio Choices (January 2010). Available at SSRN: https://ssrn.com/abstract=1566889 or http://dx.doi.org/10.2139/ssrn.1566889

Fathi Abid (Contact Author)

University of Sfax, Faculty of Economic and Management Sciences, Probability & Statistics Laboratory ( email )

Road of Airport, Km 4
Sfax, sfax 3018
Tunisia
+216 7427 9154 (Phone)

Slah Bahloul

University of Sfax - Higher Institute of Business Administration ( email )

Road of the Airport 4
Sfax, BP 1013
Tunisia

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