Moments of Multivariate Regime Switching with Application to Risk-Return Trade-Off Articles uri icon

authors

  • TAAMOUTI, ABDERRAHIM

publication date

  • March 2012

start page

  • 292

end page

  • 308

issue

  • 2

volume

  • 19

International Standard Serial Number (ISSN)

  • 0927-5398

Electronic International Standard Serial Number (EISSN)

  • 1879-1727

abstract

  • We use a Fourier transform to derive multivariate conditional and unconditional moments of multi-horizon returns under a regime-switching model. These moments are applied to examine the relevance of risk horizon and regimes for buy-and-hold investors. We analyze the impact of time-varying expected returns and risk (variance and covariance) on portfolio allocations' "term structure"—portfolio allocations as a function of the investment horizon. Using monthly observations on S&P composite index and 10-year Government Bond, we find that the term structure of the optimal allocations depends on market conditions measured by the probability of being in bull state. At short horizons and when this probability is low, buy-and-hold investors decrease their holdings of risky assets. We also find that the conditional optimal portfolio performs quite well at short and intermediate horizons and less at long horizons.

keywords

  • markov switching; characteristic function; multivariate moments; mean-variance; term structure