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Equity portfolio diversification under time-varying predictability and comovements: evidence from Ireland, the US, and the UK

Author

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  • Massimo Guidolin
  • Stuart Hyde
Abstract
We use multivariate regime switching vector autoregressive models to characterize the time-varying linkages among short-term interest rates (monetary policy) and stock returns in the Irish, the US and UK markets. We find that two regimes, characterized as bear and bull states, are required to characterize the dynamics of returns and short-term rates. This implies that we cannot reject the hypothesis that the regimes driving the markets in the small open economy are largely synchronous with those typical of the major markets. We compute time-varying Sharpe ratios and recursive mean-variance portfolio weights and document that a regime switching framework produces out-of-sample portfolio performance that outperforms simpler models that ignore regimes. Interestingly, the portfolio shares derived under regime switching dynamics implies a fairly low commitment to the Irish market, in spite of its brilliant unconditional risk-return trade-off.

Suggested Citation

  • Massimo Guidolin & Stuart Hyde, 2008. "Equity portfolio diversification under time-varying predictability and comovements: evidence from Ireland, the US, and the UK," Working Papers 2008-005, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2008-005
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    References listed on IDEAS

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    4. Hsin, Chin-Wen & Tseng, Po-Wen, 2012. "Stock price synchronicities and speculative trading in emerging markets," Journal of Multinational Financial Management, Elsevier, vol. 22(3), pages 82-109.

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