Dynamic asset allocation strategy using a state-dependent Markov model: Applications to international equity markets

Roksana Hematizadeh, Reza Tajaddini and Terrence Hallahan

Journal of International Money and Finance, 2022, vol. 128, issue C

Abstract: This paper investigates the performance of an asset allocation strategy that relies on the state-dependent correlation between emerging and developed markets. We utilize a state-dependent Markov Model that employs a time-varying transition probability and uses the U.S. term spread differential as a market phase identifier. We show that by relying on the spillover effect of U.S. monetary policies on international equity markets, international investors can optimize returns on their investments by using a state-dependent model when diversifying their portfolios towards less volatile markets. Two states and optimal tangency portfolios reveal superior performance even after consideration of transaction costs. The effect of the U.S. term spread on equity returns is more apparent after the Global Financial Crisis; when positive (negative) term spread differentials are associated with an increased likelihood of being in a bull (bear) market.

Keywords: Dynamic asset allocation; State-dependent strategy; Transaction costs; International markets; Financial crisis (search for similar items in EconPapers)
JEL-codes: G01 G11 G15 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:128:y:2022:i:c:s0261560622001085

DOI: 10.1016/j.jimonfin.2022.102705

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