Macroeconomic Influences on Optimal Asset Allocation
44 Pages Posted: 14 Feb 2002
Date Written: January 2002
Abstract
We develop a tactical asset allocation strategy that incorporates the effects of macroeconomic variables. The joint distribution of financial asset returns and the macroeconomic variables is modelled using a VAR with an M-GARCH error structure. As a result the portfolio frontier is time varying and subject to contagion from the macroeconomic variable. Optimal asset allocation requires that this be taken into account. We illustrate the how to do this using three risky UK assets and inflation as a macroeconomic factor. Taking account of inflation generates portfolio frontiers that lie closer to the origin, and offers investors superior risk-return combinations.
Keywords: Asset allocation, macroeconomic effects, multivariate GARCH
JEL Classification: G11
Suggested Citation: Suggested Citation
CESifo (Center for Economic Studies and Ifo Institute)
Poschinger Str. 5
Munich, DE-81679
Germany
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