Size and Value Anomalies under Regime Shifts

Guidolin, Massimo; Timmermann, Allan

doi:10.2139/ssrn.676545

Cited by 47 publications

(64 citation statements)

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“…This setup allows them to apply quadrature methods based on a discretization grid (see also Guidolin and Timmermann, 2005). Our framework is quite different since we treat the state as unobservable and calculate asset allocations under optimal filtering (3).…”

Section: Resultsmentioning

confidence: 99%

“…To quantify the utility costs of restricting the investor's asset allocation problem, we follow Ang and Bekaert (2002) and Guidolin and Timmermann (2005). Callω R t the vector of portfolio weights obtained by imposing restrictions on the portfolio problem, for instance, when the investor is forced to avoid small capitalization firms.…”

Section: Welfare Cost Measuresmentioning

confidence: 99%

“…We have therefore computed afresh optimal portfolio weights when the joint process of returns is described by the DCC EGARCH ( 27 Detailed results and parameter estimates are available upon request. 28 Some more details are needed for replicability: for purposes of computation of predicted returns, the VAR (1) is initialized at the unconditional means for each of the return series (these unconditional means are regime-dependent in case of regime switching); in the DCC EGARCH variances and covariances are initialized at their unconditional levels (these are by construction equal to their sample estimates). For the regime switching model, calculations initialize state probabilities at their ergodic values.…”

Section: The Return Generating Processmentioning

confidence: 99%

“…Second, U.S. small caps have experienced an unprecedented performance in the first part of our sample, from January 1999 to June 2001. Since a concern has been expressed that the size premium may contain long and persistent swings (see Pástor, 2000 andTimmermann, 2005), it is useful to obtain evidence involving at least one additional, major market for small caps.…”

Section: Introductionmentioning

confidence: 99%

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Small caps in international equity portfolios: the effects of variance risk

Guidolin¹,

Nicodano

2008

Ann Finance

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We show that predictable covariances between means and variances of stock returns may have a first order effect on portfolio composition. In an international asset menu that includes both European and North American small capitalization equity indices, we find that a three-state, heteroskedastic regime switching VAR model is required to provide a good fit to weekly return data and to accurately predict the dynamics in the joint density of returns. As a result of the non-linear dynamic features revealed by the data, small cap portfolios become riskier in bear markets, i.e. display negative co-skewness with other stock indices. Because of this property, a power utility investor ought to hold a well-diversified portfolio, despite the high risk premium and Sharpe ratios offered by small capitalization stocks. On the contrary small caps command large optimal weights when the investor ignores variance risk, by incorrectly assuming joint normality of returns. These results provide the missing partial equilibrium rationale for the presence of co-skewness in the empirical asset pricing models that have been proposed to explain the cross-section of stock returns.Keywords: intertemporal portfolio choice; return predictability; co-skewness and co-kurtosis; international portfolio diversification.JEL code: G11, G15, F30, C32. AbstractWe show that predictable covariances between means and variances of stock returns may have a first order effect on portfolio composition. In an international asset menu that includes both European and North American small capitalization equity indices, we find that a three-state,heteroskedastic Markov switching VAR model is required to provide a good fit to weekly return data and to accurately predict the dynamics in the joint density of returns. As a result of the non-linear dynamic features revealed by the data, small cap portfolios become riskier in bear markets, i.e. display negative co-skewness with other stock indices. Because of this property, a power utility investor ought to hold a well-diversified portfolio, despite the high risk premium and Sharpe ratios offered by small capitalization stocks. On the contrary small caps command large optimal weights when the investor ignores variance risk, by incorrectly assuming joint normality of returns. These results provide the missing partial equilibrium rationale for the presence of coskewness in the empirical asset pricing models that have been proposed to explain the cross-section of stock returns.2

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Section: Resultsmentioning

confidence: 99%

Section: Welfare Cost Measuresmentioning

confidence: 99%

Section: The Return Generating Processmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

See 2 more Smart Citations

Small caps in international equity portfolios: the effects of variance risk

Guidolin¹,

Nicodano

2008

Ann Finance

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“…Even though they have been analyzed for portfolio allocation decisions at the monthly frequency, e.g. Guidolin and Timmermann (2008) and Patton (2004), to our knowledge no existing study has investigated the bivariate density forecast model for value and growth portfolios at the daily frequency.…”

Section: Empirical Illustrationmentioning

confidence: 99%

Autocontour-based evaluation of multivariate predictive densities

González‐Rivera

Yoldaş

2012

International Journal of Forecasting

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Equity prices and financial globalization

Jinjarak

2014

International Review of Financial Analysis

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This article appeared in a journal published by Elsevier. The attached copy is furnished to the author for internal non-commercial research and education use, including for instruction at the authors institution and sharing with colleagues.Other uses, including reproduction and distribution, or selling or licensing copies, or posting to personal, institutional or third party websites are prohibited. This paper examines the association between equity returns, economic shocks, and economic integration. The empirical findings show that oil prices and U.S. Federal Reserve funds rates are associated with negative responses of international equity returns, of which a simple asset-pricing model is capable of explaining the international differences. Using vector autoregressions, we find that the effects of global economic shocks operate through the current excess returns of equity prices. Empirically, trade integration increases the responses of international equity returns to oil prices, while finance integration increases the responses of equity returns to Federal Reserve funds rates across countries.

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Size and Value Anomalies under Regime Shifts

Cited by 47 publications

References 60 publications

Small caps in international equity portfolios: the effects of variance risk

Small caps in international equity portfolios: the effects of variance risk

Autocontour-based evaluation of multivariate predictive densities

Equity prices and financial globalization

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