Equity portfolio diversification under time-varying predictability and comovements: evidence from Ireland, the US, and the UK

Massimo Guidolin and Stuart Hyde

No 2008-005, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We use multivariate regime switching vector autoregressive models to characterize the time-varying linkages among short-term interest rates (monetary policy) and stock returns in the Irish, the US and UK markets. We find that two regimes, characterized as bear and bull states, are required to characterize the dynamics of returns and short-term rates. This implies that we cannot reject the hypothesis that the regimes driving the markets in the small open economy are largely synchronous with those typical of the major markets. We compute time-varying Sharpe ratios and recursive mean-variance portfolio weights and document that a regime switching framework produces out-of-sample portfolio performance that outperforms simpler models that ignore regimes. Interestingly, the portfolio shares derived under regime switching dynamics implies a fairly low commitment to the Irish market, in spite of its brilliant unconditional risk-return trade-off.

Keywords: Stock; exchanges (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-eec, nep-mac and nep-rmg
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Citations: View citations in EconPapers (4)

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