International Portfolio Allocation: The Role of Conditional Higher Moments
Posted: 17 Jan 2020
Date Written: April 23, 2019
I explore the benefits of incorporating conditional higher moments in the international portfolio allocation. The quantile-based conditional higher moments are robust to the outliers and exhibit considerable time-variation and heterogeneity across countries. My empirical evidence shows that emerging market returns have favourable conditional skewness but are more exposed to extreme returns with higher kurtosis. In the international portfolio, the investor tilts her portfolio towards countries with higher skewness and less kurtosis, consistent with her moment preference in theory. An investor with moderate risk aversion would be willing to pay 210 basis points per year to switch from a three-moment portfolio to the portfolio that employs both conditional skewness and kurtosis. The results are robust to real-time investing strategy, transaction costs and alternative model specifications.
Keywords: Mixed Data Sampling (MIDAS), Higher moments, Parametric Portfolio, International Diversification
JEL Classification: C14, F65, G11, G15
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