Dynamic Asset Allocation with Regime Shifts and Long Horizon CVaR-Constraints

Abstract

We analyse portfolio policies for investors who invest optimally for given investment horizons with respect to Conditional Value-at-Risk constraints. We account for nonnormally distributed, skewed, and leptokurtic asset return distributions due to regime shifts. The focus is on standard CRRA utility with a money back guarantee at maturity, which is often augmented to individual retirement plans. Optimal solutions for the unconstrained as well as the constrained policy are provided and examined for risk management costs calculated as welfare losses. Our results confirm previous findings that money back guarantees yield mild downside protection at low economic costs for most long term investors.

Regime-Switching Factor Investing with Hidden Markov Models

“…Research has shown that market regime detection can improve returns on a portfolio across different markets, often through avoidance of persistent high-volatility periods (Kritzman et al 2012). Dynamic asset allocation based on the identification of market regimes has also been proven to be advantageous in investing (Vo and Maurer 2013). The importance of recognizing market regimes and their impact on portfolio performance has led to the development and application of regime-switching models.…”