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CONTRIBUTORS:
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JOURNAL:
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YEAR:
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2006
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PUB TYPE:
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Journal Article
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SUBJECT(S):
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Regime switching; Style investing; Markov Chain Monte Carlo; Tactical asset allocation;
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DISCIPLINE:
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Economics
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HTTP:
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http://www.manuel-ammann.com
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LANGUAGE:
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English
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PUB ID:
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103-436-734
(Last edited on
2007/07/30 09:36:51 GMT-6)
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SPONSOR(S):
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ABSTRACT:
We analyse time-varying risk premia and the implications for portfolio choice. Using Markov Chain Monte Carlo (MCMC) methods, we estimate a multivariate regime-switching model for the Carhart (1997) four-factor model. We find two clearly separable regimes with different mean returns, volatilities, and correlations. In the High-Variance Regime, only value stocks deliver a good performance, whereas in the Low-Variance Regime, the market portfolio and momentum stocks promise high returns. Regime-switching induces investors to change their portfolio style over time depending on the investment horizon, the risk aversion, and the prevailing regime. Value investing seems to be a rational strategy in the High-Variance Regime, momentum investing in the Low-Variance Regime. An empirical out-of-sample backtest indicates that this switching strategy can be profitable, but the overall forecasting ability for the regime-switching model seems to be weak compared to the iid model.
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STATISTICS
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