Proceedings of the 2nd Economics & Finance Conference, Vienna

GLOBAL PORTFOLIO MANAGEMENT UNDER STATE DEPENDENT MULTIPLE RISK PREMIA

TIMOTHEOS ANGELIDIS, NIKOLAOS TESSAROMATIS

Abstract:

In this paper, we assess the benefits from international factor diversification under a regime based portfolio construction framework that takes into account the dynamic changes in stock markets. We show that there are significant costs to investors who fail to (a) pursue an international diversification strategy using sources of return other than the market premium and (b) take into account the existence of regimes in portfolio construction and asset allocation. Short sale and tracking error constraints reduce but do not eliminate the gains from a dynamic global factor portfolio. Implementation through commercially available, investable factor indices to provide efficient and low cost building blocks to construct a dynamic diversified factor portfolio in practice preserves most of the benefits from state dependent portfolio construction.

Keywords: Diversification benefits, Factor returns, Regime Switching Models.

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