How do Regimes Affect Asset Allocation?
NBER Working Paper No. 10080
International equity returns are characterized by episodes of high volatility and unusually high correlations coinciding with bear markets. We develop models of asset returns that match these patterns and use them in asset allocation. First, the presence of regimes with different correlations and expected returns is difficult to exploit within a framework focused on global equities. Nevertheless, for all-equity portfolios, a regime-switching strategy dominates static strategies out-of-sample. Second, substantial value is added when an investor chooses between cash, bonds and equity investments. When a persistent bear market hits, the investor switches primarily to cash. There are large market timing benefits because the bear market regimes tend to coincide with periods of relatively high interest rates.
Document Object Identifier (DOI): 10.3386/w10080
Published: Ang, Andrew and Geert Bekaert. "How Regimes Affect Asset Allocation," Financial Analsts Journal, 2004, v60(2,Mar/Apr), 86-99.
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