Economics at your fingertips  

Properties of the Margrabe Best-of-two strategy to tactical asset allocation

David Ardia, Kris Boudt, Stefan Hartmann and Giang Nguyen

International Review of Financial Analysis, 2022, vol. 81, issue C

Abstract: The Margrabe Best-of-two (MBo2) strategy is a rule-based dynamic investment solution for the two-asset allocation problem. Its typical implementation involves yearly rebalancing the portfolio weights to 50–50 between a low-risk and high-risk asset. It uses intra-year weight adjustments to chase the momentum of the best performing asset by replicating the Margrabe formula for the value of a European option to exchange an asset for another asset at year-end. In practice, this means that the Margrabe portfolio allocation benefits from the upside potential of the high-risk asset and the downside protection from the low-risk asset. The MBo2 allocation depends on the assets' prices, their return volatilities, and correlation, as well as the remaining time until year-end. In this paper, we derive analytical formulae and use simulations to provide insights into the sensitivity of the strategy's weights and performance to these input parameters. We also report the results of an extensive out-of-sample evaluation for the MBo2 strategy applied to the bond–equity, real estate–equity, and world equity–emerging market equity portfolio allocation problems.

Keywords: Best-of-two; Bond-equity; Margrabe; Tactical asset allocation; Upside potential; Downside protection (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

DOI: 10.1016/j.irfa.2018.12.014

Access Statistics for this article

International Review of Financial Analysis is currently edited by B.M. Lucey

More articles in International Review of Financial Analysis from Elsevier
Bibliographic data for series maintained by Catherine Liu ().

Page updated 2023-06-15
Handle: RePEc:eee:finana:v:81:y:2022:i:c:s105752191830190x