Abstract
This article proposes a straightforward Markov-switching asset allocation model, which reduces the market exposure to periods of high volatility. The main purpose of the study is to examine the performance of a regime-based asset allocation strategy under realistic assumptions, compared to a buy-and-hold strategy. An empirical study, utilizing daily return series of major equity indices in the United States, Japan and Germany over the past 40 years, investigates the performance of the model. In an out-of-sample context, the strategy proves profitable after taking transaction costs into account. For the regional markets under consideration, the volatility reduces on average by 41 per cent. In addition, annualized excess returns attain 18.5 to 201.6 basis points.
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Acknowledgements
We sincerely thank P. Thomson and W. Zucchini for their inspiring comments and support. We also render thanks to the participants of the Cherry Bud Workshop 2007 and the 17th NZESG for helpful feedback. Not to forget, we thank G. Allardice for editorial assistance, as well as W. Allardice and Prof. D. Vere-Jones for the great working environment. Jan Bulla was supported by a fellowship within the Postdoc-Program of the German Research Foundation (DFG).
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4holds a PhD in mathematics, his main research interests lie in statistics and probability theory. He teaches classes in statistics, probability theory and computer science up to graduate level at the mathematics department of Caen University. Moreover, he is involved in a research program with the department of biology and has published in the field of algebra.
5received the PhD degree in Statistics in 2006 from the University of Pierre et Marie Curie, Paris 6, France. Currently he is an associate professor in the Department of Mathematical Sciences of Caen University. His current research deals with non-parametric statistics, wavelets, Markov processes, econometrics and finance. His teaching experience includes a number of undergraduate level modules in the area of probability and econometrics.
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Bulla, J., Mergner, S., Bulla, I. et al. Markov-switching asset allocation: Do profitable strategies exist?. J Asset Manag 12, 310–321 (2011). https://doi.org/10.1057/jam.2010.27
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DOI: https://doi.org/10.1057/jam.2010.27