Strategic Asset Allocation and Markov Regime Switch with GARCH Model

JBES, Forthcoming

Posted: 27 Jan 2010 Last revised: 16 Jan 2013

Date Written: January 26, 2010

Abstract

During the financial crisis of 2008, the S&P 500 Implied Volatility Index (VIX), known as the “fear gauge”, jumped to 80% of the highest level it has ever reached. Portfolio managers faced tremendous pressures in these environments of such high levels market volatility. Because it is well known that asset allocation dominates portfolio performances, this paper focuses on asset allocation strategies. It develops a strategic asset allocation solution for portfolio management under all conditions and at all levels of market volatility. The approach is to derive a dynamic optimal portfolio that is based on the well-known asset allocation Black–Litterman [1991, 1992] framework. In addition, this paper proposes a methodology that considers the features of volatility regime-switching over time. This new strategic framework allows portfolio managers to derive a systematically optimal portfolio in a timely, accurate fashion.

Keywords: Portfolio Optimization, Asset Allocation, Regime Switching, VIX, volatility

JEL Classification: G11, G15

Suggested Citation

Simi, Wei, Strategic Asset Allocation and Markov Regime Switch with GARCH Model (January 26, 2010). JBES, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1542826 or http://dx.doi.org/10.2139/ssrn.1542826

Wei Simi (Contact Author)

City University of New York ( email )

New York, NY
United States

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