Cross-industry asset allocation with the spatial interaction on multiple risk transmission channels

Abstract

Taking into consideration the real link and information risk transmission channels, we used a spatial econometric approach to construct an economic distance-based spatial weight matrix, which can capture the spatial interaction across industries, and built a return estimation model with spatial interaction using the matrix. On this basis, we derived the covariance matrix and constructed the cross-industry asset allocation model. The empirical results showed that 1) the spatial interaction has a strong explanatory power to return and integrating the spatial interaction on multiple risk transmission channels can improve the effectiveness of the return estimation model; 2) the covariance matrix includes unsystematic risk (idiosyncratic risk) and systematic risk (market risk and cross-industry spillover risk); 3) the asset allocation model with spatial interaction can improve the performance of the portfolio and provide a valuable reference for investors' risk management and investment decision.