Cross-Region, Cross-Sector Asset Allocation with Regimes

52 Pages Posted: 9 Aug 2010 Last revised: 27 Jan 2013

See all articles by Yiwen (Paul) Dou

Yiwen (Paul) Dou

Macquarie University

David R. Gallagher

Rozetta Institute

David Schneider

UniSuper Management Limited

Terry S. Walter

University of Sydney; University of Technology, Sydney - School of Finance and Economics; Financial Research Network (FIRN)

Date Written: June 29, 2010

Abstract

Cross-region and cross-sector asset allocation decisions are one of the most fundamental issues in international equity portfolio management. Equity returns exhibit higher volatilities and correlations, and lower expected returns, in bear markets compared to bull markets. However, static mean-variance analysis fails to capture this salient feature of equity returns. Using a regime switching model across both regions and sectors, the regime-dependent asset allocation substantially outperforms the static mean-variance allocation. This outperformance is robust to various asset allocation constraints. In addition, optimal allocation across sectors provide greater benefits compared to international diversification, which is characterized by higher returns, lower risks, lower correlations with the world market and a higher Sharpe ratio.

Keywords: strategic asset allocation, Dynamic asset allocation, International diversification, sector rotation, regime switching, Markov switching

JEL Classification: G11, E30, C22, C13

Suggested Citation

Dou, Yiwen (Paul) and Gallagher, David R. and Schneider, David and Walter, Terry Stirling, Cross-Region, Cross-Sector Asset Allocation with Regimes (June 29, 2010). 23rd Australasian Finance and Banking Conference 2010 Paper, Available at SSRN: https://ssrn.com/abstract=1655525 or http://dx.doi.org/10.2139/ssrn.1655525

Yiwen (Paul) Dou (Contact Author)

Macquarie University ( email )

North Ryde
Sydney, New South Wales 2109
Australia

David R. Gallagher

Rozetta Institute ( email )

Sydney

David Schneider

UniSuper Management Limited ( email )

Level 35, 385 Bourke Street
Melbourne, 3000
Australia

Terry Stirling Walter

University of Sydney ( email )

P.O. Box H58
Sydney, NSW 2006
Australia

University of Technology, Sydney - School of Finance and Economics ( email )

Haymarket
Sydney, NSW 2007
Australia
+61 2 9514 3860 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://datasearch.uts.edu.au/business/finance/staff/StaffDetails.cfm?UnitStaffId=5373

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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