International asset allocation under regime switching, skew and kurtosis preferences

Massimo Guidolin and Allan Timmerman

No 2005-034, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This paper proposes a new tractable approach to solving asset allocation problems in situations with a large number of risky assets which pose problems for standard approaches. Investor preferences are assumed to be defined over moments of the wealth distribution such as its mean, variance, skew and kurtosis. Time-variations in investment opportunities are represented by a flexible regime switching process. In the context of a four-moment international CAPM specification that relates stock returns in five regions to returns on a global market portfolio, we find evidence of distinct bull and bear states. Ignoring regimes, an unhedged US investor?s optimal portfolio is strongly diversified internationally. The presence of regimes in the return distribution leads to a large increase in the investor?s optimal holdings of US stocks as does the introduction of skew and kurtosis preferences. Our paper therefore offers an explanation of the strong home bias observed in US investors? asset allocation based on regime switching and skew and kurtosis preferences.

Keywords: Investments; Asset pricing; International finance (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (37)

Downloads: (external link)
http://research.stlouisfed.org/wp/2005/2005-034.pdf (application/pdf)

Related works:
Journal Article: International asset allocation under regime switching, skew, and kurtosis preferences (2008)
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: https://EconPapers.repec.org/RePEc:fip:fedlwp:2005-034

Ordering information: This working paper can be ordered from

Access Statistics for this paper

More papers in Working Papers from Federal Reserve Bank of St. Louis Contact information at EDIRC.
Bibliographic data for series maintained by Scott St. Louis ().