Monetary Policy and Risk-Based Asset Allocation

23 Pages Posted: 29 Mar 2016 Last revised: 19 Apr 2016

See all articles by Alexis Flageollet

Alexis Flageollet

NATIXIS Asset Management

Hamza Bahaji

University of Paris 9 Dauphine, DRM-Finance; NATIXIS Asset Management

Date Written: June 1, 2015

Abstract

This paper focuses on the effects of the Fed’s monetary policy on stock and bond returns co-movement and their implications to risk-based asset allocation. Using a regime-switching model that controls for the economic effects of monetary policy we identify three co-movement regimes. We document that risk-based portfolio strategies poorly perform in the low correlation regime which features inflation shocks. We find outperformance evidence under the negative correlation regime with a high stock market risk and a very accommodating Fed policy. Less effectiveness is demonstrated under the positive correlation regime where bonds are regarded as risky assets and interest rate volatility is fueled by monetary policy.

Keywords: Monetary policy, Hidden Markov Model, Co-movement, Minimum variance, Equal risk contribution

JEL Classification: E22, E58, G11, G17

Suggested Citation

Flageollet, Alexis and Bahaji, Hamza, Monetary Policy and Risk-Based Asset Allocation (June 1, 2015). Available at SSRN: https://ssrn.com/abstract=2755473 or http://dx.doi.org/10.2139/ssrn.2755473

Alexis Flageollet

NATIXIS Asset Management ( email )

21 Quai d'Austerlitz
Paris, 75013
France

Hamza Bahaji (Contact Author)

University of Paris 9 Dauphine, DRM-Finance ( email )

Place du Maréchal de Lattre de Tassigny
Cedex 16
Paris, 75775
France
00 33 6 10 30 03 67 (Phone)

NATIXIS Asset Management ( email )

21 Quai d'Austerlitz
Paris, 75013
France
0033178403633 (Phone)

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