Exploiting Predictability in International Anomalies

Abstract

We construct unconditionally efficient asset allocation strategies that exploit return predictability of international size and momentum portfolios. The strategies achieve comparable returns to these investment assets while exhibiting much lower volatility. They largely avoid major losses by successfully timing these assets. The strategies utilizing the MSCI world index and the term spread as predictive variables achieve better performance than those without exploiting return predictability. The optimal strategies perform better than conditionally efficient strategies due the conservative response of the optimal portfolio weight to extreme realizations of the predictive variables, thus leading to lower volatility.

Keywords: Asset Pricing, Return Predictability, International Diversification

JEL Classification: G11, G12, G15