Macro-Based Parametric Asset Allocation

Abstract

This paper presents a novel approach to asset class allocation which builds upon macroeconomic factors. Without doubt the financial returns of asset classes are interlinked with the economy. However, it is not clear how to bring the finance and economy world together within a portfolio's asset allocation. I propose a direct modeling of the weights with global macroeconomic risk factors. These risk factors are not asset class specific but potentially related to the returns of all asset classes. In this paper I focus on three asset classes: stocks, bonds and the risk free asset. The approach is robust, links macroeconomic factors to financial returns intuitively and outperforms a standard 60% stock and 40% bond portfolio almost twice in terms of the Sharpe Ratio - in sample and out of sample. This outperformance largely remains when considering transaction or leverage costs.

Keywords: asset allocation, macro based, parametric weights

JEL Classification: G10, G11, G17