Financial Markets and Portfolio Management

, Volume 20, Issue 3, pp 309–337 | Cite as

The Effect of Market Regimes on Style Allocation

  • Manuel Ammann
  • Michael Verhofen


We analyse time-varying risk premia and the implications for portfolio choice. Using Markov Chain Monte Carlo (MCMC) methods, we estimate a multivariate regime-switching model for the Carhart (1997) four-factor model. We find two clearly separable regimes with different mean returns, volatilities, and correlations. In the High-Variance Regime, only value stocks deliver a good performance, whereas in the Low-Variance Regime, the market portfolio and momentum stocks promise high returns. Regime-switching induces investors to change their portfolio style over time depending on the investment horizon, the risk aversion, and the prevailing regime. Value investing seems to be a rational strategy in the High-Variance Regime, momentum investing in the Low-Variance Regime. An empirical out-of-sample backtest indicates that this switching strategy can be profitable, but the overall forecasting ability for the regime-switching model seems to be weak compared to the iid model.


Regime switching Style investing Markov Chain Monte Carlo Tactical asset allocation 

JEL Classification Numbers

G11 G12 G14 


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Copyright information

© Swiss Society for Financial Market Research 2006

Authors and Affiliations

  1. 1.Swiss Instiute of Banking and FinanceUniversity of St. GallenSt. GallenSwitzerland
  2. 2.Haas School of BusinessUniversity of CaliforniaBerkeleyUSA

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