THE TIMING OF PORTFOLIO ADJUSTMENTS: A REGIME-SWITCHING APPROACH

Guobin Fan () and Yong Zeng ()
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Guobin Fan: School of Management and Economics, University of Electronic Science and Technology of China, Chengdu, 610054, China
Yong Zeng: School of Management and Economics, University of Electronic Science and Technology of China, Chengdu, 610054, China

International Journal of Information Technology & Decision Making (IJITDM), 2012, vol. 11, issue 05, 909-933

Abstract: The fact that the relationships among the returns of financial assets tend to be nonlinear and time-varying has important implications for asset allocation. To describe these two features, this paper first combines a copula function with the Markov switching technique to model the dependence structure across assets and then builds on this Markov Switching Copula model to present a procedure for the timing of portfolio adjustments. Our empirical evidence confirms that the dependence structure between high-risk and low-risk stocks in the Shanghai and Shenzhen markets is not static but switches between regimes over the course of the sample horizon considered in this paper. More importantly, as a result of such regime-switching characteristics of their dependence structure, our analysis of the out-of-sample asset allocation performance indicates that employing the procedure proposed in this paper to identify regime changes and decide when to adjust portfolio weights allows investors with the Constant Relative Risk Aversion utility to achieve both higher realized returns and higher certainty equivalent rate of returns than does the use of strategies based on static models.

Keywords: Copula function; Markov switching; portfolio adjustment (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (2)

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DOI: 10.1142/S0219622012500265

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