Dynamic Allocation or Diversification: A Regime-Based Approach to Multiple Assets

Peter Nystrup*, Bo William Hansen, Henrik Olejasz Larsen, Henrik Madsen, Erik Lindström

*Corresponding author for this work

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

This article investigates whether regime-based asset allocation can effectively respond to changes in financial regimes at the portfolio level in an effort to provide better long-term results when compared to a static 60/40 benchmark. The potential benefit from taking large positions in a few assets at a time comes at the cost of reduced diversification. The authors analyze this trade-off in a multi-asset universe with great potential for static diversification. The regime-based approach is centered around a regime-switching model with time-varying parameters that can match financial markets’ behavior and a new, more intuitive way of inferring the hidden market regimes. The empirical results show that regime-based asset allocation is profitable, even when compared to a diversified benchmark portfolio. The results are robust because they are based on available market data with no assumptions about forecasting skills.
Original languageEnglish
JournalThe Journal of Portfolio Management
Volume44
Issue number2
Pages (from-to)62-73
Number of pages12
ISSN0095-4918
DOIs
Publication statusPublished - 2018

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