How much foreign stocks?: classical versus Bayesian approaches to asset allocation
Gespeichert in:
| Beteiligte Personen: | , |
|---|---|
| Format: | Buch |
| Sprache: | Englisch |
| Veröffentlicht: |
Frankfurt am Main
Fachbereich Wirtschaftswissenschaften
2002
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| Schriftenreihe: | Working paper series / Johann-Wolfgang-Goethe-Universität Frankfurt am Main, Fachbereich Wirtschaftswissenschaften : Finance & accounting
92 |
| Links: | http://bvbr.bib-bvb.de:8991/F?func=service&doc_library=BVB01&local_base=BVB01&doc_number=010058948&sequence=000002&line_number=0001&func_code=DB_RECORDS&service_type=MEDIA |
| Umfang: | 22 S. |
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| adam_text | How much foreign stocks?
Classical versus Bayesian approaches
Abstract
The classical approaches to asset allocation give very different conclusions about how much
foreign stocks a US investor should hold. US investors should either allocate a large portion of
about 40% to foreign stocks (which is the result of mean/variance optimization and the
international CAPM) or they should hold no foreign stocks at all (which is the conclusion of the
domestic CAPM and mean/variance spanning tests). There is no way in between.
The idea of the Bayesian approach discussed in this article is to shrink the mean/variance
efficient portfolio towards the market portfolio. The shrinkage effect is determined by the
investor s prior belief in the efficiency of the market portfolio and by the degree of violation of
the CAPM in the sample. Interestingly, this Bayesian approach leads to the same implications for
asset allocation as the mean variance/tracking error criterion. In both cases, the optimal portfolio
is a combination of the market portfolio and the mean/variance efficient portfolio with the
highest Sharpe ratio.
Applying both approaches to the subject of international diversification, we find that a
substantial home bias is only justified when a US investor has a strong belief in the global
mean/variance efficiency of the US market portfolio and when he has a high regret aversion of
falling behind the US market portfolio. We also find that the current level of home bias can be
justified whenever regret aversion is significantly higher than risk aversion.
Finally, we compare the Bayesian approach of shrinking the mean/variance efficient portfolio
towards the market portfolio to another Bayesian approach which shrinks the mean/variance
efficient portfolio towards the minimum variance portfolio. An empirical out of sample study
shows that both Bayesian approaches lead to a clearly superior performance compared to the
classical mean/variance efficient portfolio.
Keywords: Portfolio selection, asset pricing models, Bayesian inference, estimation risk,
international diversification
Table of contents
I. Introduction 1
II. Classical approaches to asset allocation 3
1. Mean/variance optimization 3
2. The implication of an asset pricing model 3
3. Mean/variance spanning tests 4
III. A Bayesian approach to asset allocation 7
1. Motivation 7
2. International diversification How much foreign stocks? 8
3. International diversification How much emerging markets? 10
4. A non Bayesian interpretation: The MVTE criterion 11
IV. Out of sample study 15
V. Conclusion 17
VI. Appendix 18
1. Methodology of the Bayesian approach to asset allocation 18
2. Decomposition of the optimal portfolio under the MVTE criterion 20
VII. References 21
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| author | Herold, Ulf Maurer, Raimond 1964- |
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| illustrated | Not Illustrated |
| indexdate | 2024-12-20T11:09:14Z |
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| language | English |
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| series2 | Working paper series / Johann-Wolfgang-Goethe-Universität Frankfurt am Main, Fachbereich Wirtschaftswissenschaften : Finance & accounting |
| spellingShingle | Herold, Ulf Maurer, Raimond 1964- How much foreign stocks? classical versus Bayesian approaches to asset allocation |
| title | How much foreign stocks? classical versus Bayesian approaches to asset allocation |
| title_auth | How much foreign stocks? classical versus Bayesian approaches to asset allocation |
| title_exact_search | How much foreign stocks? classical versus Bayesian approaches to asset allocation |
| title_full | How much foreign stocks? classical versus Bayesian approaches to asset allocation Ulf Herold ; Raimond Maurer |
| title_fullStr | How much foreign stocks? classical versus Bayesian approaches to asset allocation Ulf Herold ; Raimond Maurer |
| title_full_unstemmed | How much foreign stocks? classical versus Bayesian approaches to asset allocation Ulf Herold ; Raimond Maurer |
| title_short | How much foreign stocks? |
| title_sort | how much foreign stocks classical versus bayesian approaches to asset allocation |
| title_sub | classical versus Bayesian approaches to asset allocation |
| url | http://bvbr.bib-bvb.de:8991/F?func=service&doc_library=BVB01&local_base=BVB01&doc_number=010058948&sequence=000002&line_number=0001&func_code=DB_RECORDS&service_type=MEDIA |
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