The Regime Switching Portfolios
In this paper we develop a portfolio selection theory under regime switching means and volatilities. We use log mean-variance as the portfolio selection criteria and, as a result, the theory is made substantially easier to implement than other existing theories. Moreover, the estimated regimes are easy to interpret as one of the regimes corresponds to the business cycle turning points. Finally, we conduct an asset allocation simulation and obtain reasonable results by introducing an idea of switching volatility targets.
KeywordsMarkov switching model Continuous-and discrete-time regime switching Log mean-variance Portfolio selection EM algorithm
Unable to display preview. Download preview PDF.
- Breiman, L. (1961). Optimal gambling systems for favorable games. In Proceedings of the 4th Berkeley symposium on mathematical statistics and probability (Vol. I, pp. 65–78).Google Scholar
- Campbell J. Y., Viceira L. M. (2002) Strategic asset allocation: Portfolio choice for long-term investors. Oxford University Press, OxfordGoogle Scholar
- Dempster A. P., Laird N. M., Rubin D. B. (1977) Maximum likelihood from incomplete data via the EM algorithm. Journal of the Royal Statistical Society Series B 39: 1–38Google Scholar
- Diebold F. X., Lee J., Weinbach G. C. (1994) Regime switching with time-varying transition probabilities. In: Hargreaves C. (eds) Nonstationary time series analysis and cointegration. Oxford University Press, Oxford, pp 283–302Google Scholar
- Elliott R. J., Aggoun L., Moore J. B. (1995) Hidden Markov models: Estimation and control. Springer, New YorkGoogle Scholar
- Hamilton J. D. (1994) Time series analysis. Princeton University Press, PrincetonGoogle Scholar
- Kelly J. L. (1956) A new interpretation of information rate. Bell System Technical Journal 35: 917–926Google Scholar
- Krolzig, H. (1997). Markov-switching vector autoregressions: Modelling, statistical inference, and application to business cycle analysis. Lecture Notes in Economics and Mathematical Systems (Vol. 454). Berlin: Springer.Google Scholar
- Mizrach B., Watkins J. (1999) A Markov switching cookbook. In: Rothman P. (eds) Nonlinear time series analysis of economic and financial data. Kluwer, BostonGoogle Scholar
- Perez-Quiros G., Timmermann A. (1998) Variations in the mean and volatility of stock returns around turning points of the business cycle. In: Knight J., Satchell S. (eds) Forecasting volatility in the financial markets. Butterworth-Heinemann, OxfordGoogle Scholar
- Thorp, E. O. (1971). Portfolio choice and the Kelly criterion. In Proceedings of the 1971 Business and Economics Section of the American Statistical Association (pp. 215–224).Google Scholar