Feedback Trading and International Portfolio Allocation

Abstract

This paper explores the effect of feedback trading on expected returns and international portfolio allocation using stock market data for the US and Latin America. Autocorrelation in monthly returns are shown to vary with volatility as suggested by the Shiller-Sentana-Wadhwani feedback trading model. While the feedback model fits the data considerably better than a conditional version of the zero-beta CAPM, differences between the feedback model and alternative models with a first-order autoregressive term are more modest. Global factors have no explanatory power for expected returns in addition to the feedback model. Investors can improve their portfolio optimization between developed and emerging stock markets by taking feedback trading into consideration.

Keywords: asset pricing, international finance, portfolio management

JEL Classification: G11, G12, G15