Working Paper: NBER ID: w10080
Authors: Andrew Ang; Geert Bekaert
Abstract: International equity returns are characterized by episodes of high volatility and unusually high correlations coinciding with bear markets. We develop models of asset returns that match these patterns and use them in asset allocation. First, the presence of regimes with different correlations and expected returns is difficult to exploit within a framework focused on global equities. Nevertheless, for all-equity portfolios, a regime-switching strategy dominates static strategies out-of-sample. Second, substantial value is added when an investor chooses between cash, bonds and equity investments. When a persistent bear market hits, the investor switches primarily to cash. There are large market timing benefits because the bear market regimes tend to coincide with periods of relatively high interest rates.
Keywords: No keywords provided
JEL Codes: F30; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market regimes (P10) | asset return behavior (G40) |
| bear market regime (E32) | higher correlations between returns (C10) |
| regime-switching strategy (C34) | outperform static strategies (C69) |
| persistent bear market (E32) | switch to cash investments (G11) |