International Asset Allocation Research Articles

Media Negativity on Foreign Countries and International Asset Allocation

Media Negativity on Foreign Countries and International Asset Allocation

Optimal Pension Fund Management with Foreign Investment in a Stochastic Environment

To ensure the success of a pension plan under a self-contained defined contribution (DC) retirement plan, the inclusion of foreign assets in a local pension portfolio could be beneficial for risk diversification and the efficient improvement of a fund’s investment performance during its accumulation phase. This study focuses on developing international asset allocation criteria for a DC pension plan; accordingly, we consider risk exposure relative to stochastic interest rates and ex- change rates with minimum guarantees. An arbitrage-free framework, namely, the cross-currency Heath–Jarrow–Morton interest rate model, is introduced in dynamic optimization programming for the DC pension fund. The proposed solution based on the generalized stochastic framework provides tractable and appropriate criteria for the dynamic allocation of a DC pension fund. The constituents of the optimal solution can reflect changes in investment lifecycles and shifts in risk preferences during the accumulation phase of a DC pension plan.

International Fund Allocation under Economic Policy Uncertainty Shock

Abstract This paper focuses on the impact of economic policy uncertainty on international asset allocation and international capital flows. Our results show that economic policy uncertainty shocks have a negative impact on the international asset allocation, which can be explained from the real economic activity channel and the expectation channel. We also explore a full fledge of country level heterogeneities about the economic policy uncertainty shocks on international asset allocation. Specifically, good institutional quality, transparent information, good information access to the international financial market and bilateral informational link help to alleviate the negative effect that economic policy uncertainty shock does to asset allocation. And a healthy public and external sector also help to alleviate the negative effect. While the importance of government in the economy amplifies the negative effect of economic policy uncertainty shocks to asset allocation. JEL classification numbers: E44, G11, G15. Keywords: Economic policy uncertainty, Global fund allocation, Institutional quality, Global imbalance.

Can Return Forecasts Enhance International Asset Allocation? Evidence from the Sum-of-Parts Approach

Can Return Forecasts Enhance International Asset Allocation? Evidence from the Sum-of-Parts Approach

Optimal asset allocation strategies for international equity portfolios: A comparison of country versus industry optimization

With greater economic and financial market integration, it is critical for asset managers to choose the investment universe that provides superior diversification and performance opportunities. Therefore, it is important to investigate whether international diversification benefits arise from industry rather than country allocations. We employ various asset allocation strategies such as 1/N, Risk-Parity, Minimum-Variance as well as Mean-Variance, Bayes-Stein and Black-Litterman to analyze whether an industry-based or a country-based approach provides a superior performance. We also investigate time-varying effects for expansionary and recessionary sub-periods, equity-only and equity-bond portfolios as well as portfolios with and without short positions. For the 1986–2020 period, we find that industry-based asset allocation strategies attain higher Sharpe and Omega ratios and higher alphas compared to country-based allocations. The Sharpe ratio differences are economically relevant yet statistically insignificant in many analyzed settings. The outperformance of sector allocations are independent of the optimization approach and implemented constraints and whether bonds are included in the investment universe. This is consistent with the observation that countries have become more integrated and higher correlated than industries, resulting in lower country and relatively higher industry diversification benefits. Especially for periods with unpredictable shocks, industry allocations have superior performance. Our results have important implications for international asset allocation decisions.

How do economic policy uncertainties affect stock market volatility? Evidence from G7 countries

AbstractThis study explores the dynamic and frequency spillover characteristics between economic policy uncertainty (EPU) and stock market realized volatility (RV) in G7 countries. We apply the monthly data of country‐specific economic policy uncertainty indices and realized volatility to calculate the directional spillover indicator. Then we use a Fourier transformation to calculate the frequency of spillovers to study the duration of the spillover effect. We find that the spillover effect of EPU on stock market volatility is relatively large in the U.S., Japan and Canada, and has certain regional similarities. EPU has longer spillover effects on the stock markets of France, Germany and Italy, which is strongest over 3–18 months. Finally, important economic events such as the financial crisis and the Brexit, increased EPU spillover level and lasting time. We provide the dynamic and frequency spillover characteristics between EPU and the stock market in G7 countries, making this study useful for international asset allocation and risk management.

Defined Benefit Pension Plan Liabilities and International Asset Allocation

Despite the integration of international capital markets and the relaxation of capital controls, U.S. defined benefit pension plans do not sufficiently diversify their assets across international holdings. In this paper, we explore whether incorporating liabilities in the asset allocation decision can help explain pension plans' home bias. We find that incorporating pension liabilities proves not to explain pension plan home bias in the case when returns are nominal. Furthermore, when we focus on real returns, incorporating pension plan liabilities makes the home bias puzzle worse. The fact remains that U.S. defined benefit pension plans could benefit substantially from more international investment.

Herding in frontier markets: evidence from the Balkan region

PurposeThe purpose of this paper is to examine herding in four frontier markets in the Balkan region, namely, Bulgaria, Croatia, Romania and Slovenia, from October 2000 to December 2016.Design/methodology/approachThe author employs Chang et al.’s (2000) cross-sectional dispersion approach to capture herding, while also testing for the global financial crisis’ effects and the European Union (EU)/Euro zone accession effects over herding. Potential asymmetric herding effects conditional on market performance, domestic volatility, German and US investor sentiment are also examined. Finally, the cross-market herding dynamics of the region are also explored.FindingsOverall, Romania exhibits the most extensive evidence of herding across various estimations. The empirical results indicate that cross-market herding dynamics within the region generate stronger herding (compared to the herding observed within each stock market individually), suggesting that Balkan stock exchanges’ growing financial integration leads their herding to be “imported”, rather than domestically motivated.Practical implicationsThe findings provide useful insights for regulators in frontier markets, considering the destabilising potential of herding; they are also of particular interest to the investment community for reasons of international asset allocation, diversification and hedging strategies.Originality/valueThis study contributes to the limited herding literature regarding frontier markets and provides novel findings regarding the herding dynamics in the Balkan region, the EU/Euro zone accession’s effect and global factors’ impact on herding estimations.

Discussion of "Liability of Foreignness: The Impact of Elimination of the Reconciliation Requirement on International Asset Allocation by U.S. Investors"

Discussion of "Liability of Foreignness: The Impact of Elimination of the Reconciliation Requirement on International Asset Allocation by U.S. Investors"

Optimal Asset Allocation Strategies for International Equity Portfolios

With greater economic and financial market integration, it is critical for asset managers to choose the investment universe that provides superior diversification and performance op-portunities. Therefore, it is important to investigate whether international diversification benefits arise from industry rather than country allocations. We employ various asset alloca-tion strategies such as 1/N, ‘Risk-Parity’, Minimum-Variance as well as Mean-Variance, Bayes-Stein and Black-Litterman to analyze whether an industry-based or a country-based approach provides a superior performance. We also investigate time-varying effects for ex-pansionary and recessionary sub-periods, equity-only and equity-bond portfolios as well as portfolios with and without short positions. For the 1986-2020 period, we find that industry-based asset allocation strategies attain higher Sharpe and Omega ratios and higher alphas compared to country-based allocations. The Sharpe ratio differences are economically rele-vant yet statistically insignificant in many analyzed settings. The outperformance of sector allocations are independent of the optimization approach and implemented constraints and whether bonds are included in the investment universe. This is consistent with the observa-tion that countries have become more integrated and higher correlated than industries, re-sulting in lower country and relatively higher industry diversification benefits. Especially for periods with unpredictable shocks, industry allocations have superior performance. Our results have important implications for international asset allocation decisions.

Less pain, more gain: Volatility-adjusted residual momentum in international equity markets

ABSTRACTWe offer a new type of momentum strategy — the volatility-adjusted residual momentum (VARMOM) — which is based on average past residuals scaled with their volatility. We demonstrate its application for international asset allocation within 51 country indexes and 888 industry portfolios from developed and emerging markets. The VARMOM trading strategy notably outperforms and subsumes a standard momentum strategy, delivering Sharpe ratios that are two to three times higher. The VARMOM is particularly strong across portfolios characterised by high limits to arbitrage and following bull markets, supporting the behavioural explanation of momentum. The results are robust to alternative portfolio construction methods as well as the inclusion of trading costs and control variables. They are also valid for several subperiods and subsamples.

International asset allocation using the market implied cost of capital

The Black and Litterman (Financ Anal J 48(5):28–43, 1992) (BL) approach to portfolio optimization requires investor views on expected asset returns as an input. I demonstrate that the market implied cost of capital (ICC) is ideal for quantifying those views on a country level. I benchmark this approach against a BL optimization using time-series models as investor views, the equally weighted portfolio, and allocation methods based on stock market capitalization and GDP. I find that the ICC portfolio offers an increase in average return of 2.1 percentage points (yearly) as compared to the value-weighted portfolio, while having a similar standard deviation. The resulting difference in Sharpe ratios is statistically significant and robust to the inclusion of transaction costs, varying BL parameters, and a less strictly defined investment universe.

International asset allocation optimization with fuzzy return

This paper investigates an international asset allocation problem in a fuzzy uncertain environment, where the risk attitudes of investors are taken into consideration. Since investors are usually risk aversion, we use the possibilistic risk premium index to measure their required compensation for implementing a venture investment in the paper. Then, we present a possibilistic international asset allocation optimization model with realistic constraints. The main features of the proposed model are that we represent investors’ risk preferences by the commonly-used hyperbolic absolute risk aversion (HARA) utility function, and incorporate some realistic constraints into the proposed model to simulate the transaction in the real world financial markets. To solve the proposed model, we design a time variant differential evolution with harmony search (TVDEHS) algorithm in the paper. Finally, we provide a numerical example to demonstrate the application of the proposed model and highlight the performance of the designed algorithm.

Conditional dependence between international stock markets: A long memory GARCH-copula model approach

In this paper, we investigate the relationship between major international stock markets by taking into account the long memory in volatility under structural shifts. We use long memory GARCH-skewed student-t models for the marginal distribution modeling and copulas functions for the dependence structure investigation. Using daily international stock market data from 2003 to 2017, the empirical results show that the long memory GARCH-copula models are more appropriate than standard GARCH-copulas models in dependence modeling. Moreover, results indicate that the dependence structure increases during the global financial and European debt crisis. Furthermore, a Value-at-Risk application shows that the long memory GARCH-copula models provide more accurate multivariate market risk estimation. Therefore, the dependence structure between stock markets is affected by long memory in volatility. These findings have important implications for investors interested in international stock markets for portfolio diversification, risk management, and international asset allocation.

Liability of Foreignness: The Impact of Elimination of the Reconciliation Requirement on International Asset Allocation by U.S. Investors

ABSTRACTIn 2007, the Securities and Exchange Commission (SEC) eliminated the 20-F requirement to reconcile IFRS financial disclosures to U.S. GAAP. We find that this change in SEC regulation is associated with an overall decrease in the international asset allocation of U.S. institutional investors in European Union (E.U.) firms that are cross-listed on U.S. stock exchanges. We also find that U.S. mutual fund investors were more likely to invest in firms in countries with greater levels of investor protection and higher global visibility in the post-elimination period. A learning effect (measured as the length of time a firm is cross-listed on a U.S. stock exchange) is not, however, associated with U.S. institutional ownership. These results are robust to tests involving removal of OTC ADRs, firm-level controls, country controls, and financial controls resulting from the elimination of the 20-F reconciliation. Our results suggest that the increased information processing costs were not offset by information preparation cost savings. Our results indicate that the elimination of the 20-F reconciliation of IFRS to U.S. GAAP resulted in a loss of valuable information for U.S. institutional investors and thereby resulted in a divestment in cross-listed E.U. firms.

Predicting international stock returns with conditional price-to-fundamental ratios

Abstract Taking the perspective of international asset allocation, this paper tests if predictive regressions conditional on time-series and cross-sectional information can improve forecasts of stock index returns. We use different current price-to-fundamental ratios as predictors and condition the sample on the indicator if time-series and cross-section deliver consistent versus opposing signals. Using panel regressions, we find that only consistent ratios (i) display significant mean-reverting behavior, (ii) provide strong in-sample as well as out-of-sample evidence for return predictability, and (iii) yield economic gains in a Bayesian asset allocation framework.

Is the relationship between gold and the U.S. dollar always negative? The role of macroeconomic uncertainty

ABSTRACTThe main work of this article is to access the role of macroeconomic uncertainty in effecting the correlation between gold and the dollar. The empirical analysis is divided into two parts. Firstly, we examine the impact of macroeconomic uncertainty on short and long correlation between gold and the dollar. Secondly, we analyse the explanatory power of economic uncertainty for the abnormal market relation between gold and the dollar with a threshold model. In particular, we investigate impacts of economic uncertainty sourced from different economies. The empirical results indicate that economic uncertainty generates direct impacts on the correlation between gold and the dollar. Moreover, our results emphasize that uncertainty sourced from different economies have different impacts on the dynamics between gold and the dollar. This article also presents the relative contribution of gold and the dollar shocks to the likelihood of being in the high-uncertainty regime. These results have implications for risk management, international asset allocation and hedging strategies.

Analyst Recommendations and International Stock Market Returns

This paper shows that analyst recommendations aggregated at the country level predict international stock market returns. A trading strategy based on past country-level recommendations yields an abnormal return of around 0.9 percent per month. Aggregate analyst recommendations also predict one-quarter ahead gross domestic product, industrial production and one-year ahead aggregate earnings. Overall, our results suggest that analyst recommendations aggregated at the country level provide useful information to guide international asset allocation.

Analysts' Earnings Forecasts and International Asset Allocation

The aim of this paper is to investigate whether financial analysts’ earnings forecasts are informative from the viewpoint of allocating investments across different stock markets. Therefore we develop a country forecast indicator reflecting the analysts’ prospects for specific stock markets. The country forecast indicator is defined as the number of companies within one and the same stock market for which analysts revise their current year earnings forecast upward divided by the total number of companies for which analysts revise their current year earnings forecasts anyway. Based on the available analysts’ earnings forecasts in the Institutional Brokers Estimate System (I/E/B/S), we calculate a monthly country forecast indicator for the stock markets in Germany, France, Italy, The Netherlands, United Kingdom, and Switzerland over the period 1990 to 1994. The time-series correlations between the monthly value of the indicator and the stock market returns around the date of calculating the indicator show that stock returns rather precede than follow revisions in earnings forecasts. An investment strategy which is based on a monthly asset allocation to that stock market with the highest value of the country forecast indicator in the preceding month, gives a slight outperformance (around 3 percent excess return) compared to an equal allocation of funds to the stock markets involved.

Jump-diffusion international asset allocation

We examine international asset allocation with jump-diffusion assets in the presence of risky deviations of exchanges rates from purchasing power parity when investors consume both traded and nontraded goods. We show that adding new jump risks to existing diffusion assets does not alter investors’ original optimal portfolios of diffusion assets, as long as diffusion-risk premia remain unchanged. We also show that hedge portfolios against purchasing power parity deviations are integral parts of optimal portfolios for investors from different countries, and they can be constructed by using foreign and domestic inflation-indexed bonds. Moreover, country-specific demand for risky assets can arise from nontraded-good-specific inflation-rate-differential risks.