Tail Behavior in Portfolio Optimization for Equity Style Factors

21 Pages Posted: 28 Dec 2018

See all articles by Maria Kartsakli

Maria Kartsakli

Zurich Insurance Company Ltd.

Felix Schlumpf

Zurich Insurance Company Ltd

Date Written: October 2018


Diversification has been long considered an essential part of investing for the long term. Our paper aims to look further on portfolio diversification and how asset allocation can be optimized. We suggest that the selection of investments in a portfolio should be based on how the market behaves subject to extreme events or in other words on tail behavior. Firstly, we look at equity style factors and how they perform in the worst 10 scenarios of the market. Second, we regress ETF factor-based indices on these style factors and evaluate how much of the indices’ performance can be explained. We then construct a hypothetical portfolio and suggest a portfolio optimization strategy which takes into consideration how its assets are behaving in bad times of the market economy. Our results indicate that style factors offer diversification benefits during distress periods. As a consequence, they comprise a useful source of information when we wish to optimize the asset allocation of our portfolio.

Keywords: optimization techniques; tail events; smart beta; asset allocation model; diversification; stock market returns

JEL Classification: C6; C19; G10; G11; G15

Suggested Citation

Kartsakli, Maria and Schlumpf, Felix, Tail Behavior in Portfolio Optimization for Equity Style Factors (October 2018). Available at SSRN: https://ssrn.com/abstract=3296855 or http://dx.doi.org/10.2139/ssrn.3296855

Maria Kartsakli (Contact Author)

Zurich Insurance Company Ltd. ( email )

Hagenholzstrasse 60a
Zurich, Zurich 8050
(0)712247085 (Phone)

Felix Schlumpf

Zurich Insurance Company Ltd ( email )

Mythenquai 2
Zurich, CH-8022

HOME PAGE: http://www.zurich.com

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