Asset Allocation by Investment Professionals: Integration or Segmentation?

Home bias in international macroeconomics refers to the fact that investors around the world tend to allocate majority of their portfolios into domestic assets, despite the potential benefits to be had from international diversification. This phenomenon has been occurring across countries, over time, and across equity or bond portfolios. The bias towards domestic assets tends to be larger in developing countries relative to developed economies, with Europe characterized by the lowest equity home bias, while Central and South America—by the highest equity home bias. In addition, despite the secular decline in the level of equity home bias over time in all countries and regions, home bias still remains a robust feature of the data. Whether home bias is a puzzle depends on the portfolio allocation that one uses as a theoretical benchmark. For instance, home bias in equity portfolio is a puzzle when assessed through the lens of a simple international capital asset pricing model (CAPM) with homogeneous investors. This model predicts that investors should hold world market portfolios, namely a portfolio with the share of domestic asset equal to the share of those assets in the world market portfolio. For instance, since the share of US equity in the world capitalization in 2016 was 56%, then US investors should allocate 56% of their equity portfolio into local assets, while investing the remaining 44% into foreign equities. Instead, foreign equity comprised just 23% of US equity portfolio in 2016, hence the equity home bias. Alternative portfolio benchmark comes from the theories that emphasize costs for trading assets in international financial markets. These include transaction and information costs, differential tax treatments, and more broadly, differences in institutional environments. This research, however, has so far been unable to reach a consensus on the explanatory power of such costs. Yet another theory argues that equity home bias can arise due to the hedging properties of local equity. In particular, local equity can provide insurance from real exchange rate risk and non-tradable income risk (such as labor income risk), and thus a preference towards home equities is not a puzzle, but rather an optimal response to such risks. These theories, main advances and results in the macroeconomic literature on home bias are discussed in this article. It starts by presenting some empirical facts on the extent and dynamics of equity home bias in developed and developing countries. It is then shown how home bias can arise as an equilibrium outcome of the hedging demand in the model with real exchange rate and non-tradable labor income risk. Since solving models with portfolio choice is challenging, the recent advances in solving such models are also outlined in this article. Integrating the portfolio dynamics into models that can generate realistic asset price and exchange rate dynamics remains a fruitful avenue for future research. A discussion of additional open questions in this research agenda and suggestions for further readings are also provided.

Stock Market Integration at Home

This paper extends the model setup of Devereux and Engel (1998) to investigate how consumption home bias, capital mobility, and price-setting behavior affect the consumption volatility, expected level of consumption, and the welfare performance under alternative exchange rate regimes for a country facing foreign monetary shock. The paper then discusses the issue of the choice of exchange rate regime. According to the analysis of theoretical derivation and simulation, the following conclusions are made. First, the variance of domestic consumption is lowest under a floating exchange rate with pricing-to-market (PTM model for short), and the variance of consumption under floating exchange rate with producer-currency pricing (the PCP model for short) depends on the degree of capital mobility, the share of tradable goods, and the degree of home bias. Secondly, the fixed exchange rate (FER) will dominate the floating exchange rate in terms of the expected level of consumption. Thirdly, from the perspective of welfare performance, a floating exchange rate with pricing-to-market (PTM model) is preferable to a fixed exchange rate. A fixed exchange rate dominates a floating exchange rate with producer-currency pricing (PCP model), and the lower degree of capital mobility induces a higher welfare under fixed exchange rate but a lower welfare under PTM and PCP models.

Home bias and international capital asset pricing model with human capital

An apparent preference for domestic over foreign assets, or "home bias," has been a conspicuous feature of the behavior of many investors in Japan, both individual and institutional. This home bias has declined markedly in the past decade by some measures, but remains higher than average for mature market countries. To the extent that a strong revealed preference for domestic assets in Japan results in a suboptimal allocation of financial assets, it would represent an unexploited opportunity for higher returns on investment in a country that has recently suffered from low rates of return, and that faces the prospect of having to cover a large funding gap in social security programs. From a global perspective, an inefficient portfolio held by Japanese investors could have consequences for the prices of foreign and domestic assets.KeywordsForeign Direct InvestmentAsset AllocationForeign AssetDomestic InvestorHome BiasThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

In spite of theoretical benefits, Markowitz mean-variance (MV) optimized portfolios often fail to meet practical investment goals of marketability, usability, and performance, prompting many investors to seek simpler alternatives. Financial experts Richard and Robert Michaud demonstrate that the limitations of MV optimization are not the result of conceptual flaws in Markowitz theory but unrealistic representation of investment information. What is missing is a realistic treatment of estimation error in the optimization and rebalancing process. The text provides a non-technical review of classical Markowitz optimization and traditional objections. The authors demonstrate that in practice the single most important limitation of MV optimization is oversensitivity to estimation error. Portfolio optimization requires a modern statistical perspective. Efficient Asset Management, Second Edition uses Monte Carlo resampling to address information uncertainty and define Resampled Efficiency(TM) (RE) technology. RE optimized portfolios represent a new definition of portfolio optimality that is more investment intuitive, robust, and provably investment effective. RE rebalancing provides the first rigorous portfolio trading, monitoring, and asset importance rules, avoiding widespread ad hoc methods in current practice. The Second Edition resolves several open issues and misunderstandings that have emerged since the original edition. The new edition includes new proofs of effectiveness, substantial revisions of statistical estimation, extensive discussion of long-short optimization, and new tools for dealing with estimation error in applications and enhancing computational efficiency. RE optimization is shown to be a Bayesian-based generalization and enhancement of Markowitz’s solution. RE technology corrects many current practices that may adversely impact the investment value of trillions of dollars under current asset management. RE optimization technology may also be useful in other financial optimizations and more generally in multivariate estimation contexts of information uncertainty with Bayesian linear constraints. Michaud and Michaud’s new book includes numerous additional proposals to enhance investment value including Stein and Bayesian methods for improved input estimation, the use of portfolio priors, and an economic perspective for asset-liability optimization. Applications include investment policy, asset allocation, and equity portfolio optimization. A final chapter includes practical advice for avoiding simple portfolio design errors. A simple global asset allocation problem illustrates portfolio optimization techniques. The presentation is intuitive, rigorous and informed with institutional management experience to appeal to investment management executives, consultants, fund trustees, brokers, academics, and anyone seeking to stay abreast of the future of investment technology. With its important implications for investment practice, Efficient Asset Management’s highly intuitive yet rigorous approach to defining optimal portfolios will appeal to investment management executives, consultants, brokers, and anyone seeking to stay abreast of current investment technology. Through practical examples and illustrations, Michaud and Michaud update the practice of optimization for modern investment management.

ABSTRACTThe home bias phenomenon is a widely investigated puzzle that is still not completely resolved. Home bias is the tendency of investors to invest excessively in domestic assets, in contradiction to the traditional optimal portfolio theories. This research attempts to unveil some of the underlying drivers behind this phenomenon. We examine the relationship between home bias and the level of risk in the portfolio, the percentage of the portfolio invested in ETFs (exchange traded funds), and the investor type (institutional vs. individual). To do so, we use monthly data from the Israeli market from January 2007 to March 2018. This study is the first to investigate the relationship between home bias and the use of ETFs as a global diversification tool. ETFs have become one of the most widespread passive investment instruments for both individual and institutional investors. Our findings show that institutional investors experience less home bias compared to individual investors. Second, an increase in the level of risk in the portfolio causes an increase in home bias. Finally, the use of ETFs has a negative relationship with home bias.

We use data from the PSID to investigate how households' portfolio allocations change in response to wealth fluctuations. Persistent habits, consumption commitments, and subsistence levels can generate time-varying risk aversion with the consequence that when the level of liquid wealth changes, the proportion a household invests in risky assets should also change in the same direction. In contrast, our analysis shows that the share of liquid assets that households invest in risky assets is not affected by wealth changes. Instead, one of the major drivers of households' portfolio allocation seems to be inertia: households rebalance only very slowly following inflows and outflows or capital gains and losses.

The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation

This paper proposes a new tractable approach to solving asset allocation problems in situations with a large number of risky assets which pose problems for standard approaches. Investor preferences are assumed to be defined over moments of the wealth distribution such as its mean, variance, skew and kurtosis. Time-variations in investment opportunities are represented by a flexible regime switching process. In the context of a four-moment international CAPM specification that relates stock returns in five regions to returns on a global market portfolio, we find evidence of distinct bull and bear states. Ignoring regimes, an unhedged US investor's optimal portfolio is strongly diversified internationally. The presence of regimes in the return distribution leads to a large increase in the investor's optimal holdings of US stocks as does the introduction of skew and kurtosis preferences. Our paper therefore offers an explanation of the strong home bias observed in US investors' asset allocation based on regime switching and skew and kurtosis preferences.

PurposeThis study aims to investigate the association between Muslim individuals’ portfolio allocation choice and Islamic religiosity (levels and dimensions), controlling for risk tolerance and sociodemographic factors.Design/methodology/approachThe study uses primary data collected via survey questionnaires from a sample of 751 Muslim working individuals in Kuala Lumpur, Malaysia. Owing to the ordinal nature of the dependent variable, which reflects the levels of proportions of risky assets in portfolios, the data were analyzed using an ordered probit regression model.FindingsThe findings reveal that Islamic religiosity levels in general were insignificantly related to portfolio allocation, but that two dimensions of religiosity (virtue and obligation) significantly impact the allocations of risky assets in the portfolio. The higher the level of virtue, the lower the propensity to allocate risky assets into the portfolio. On the contrary, the higher the level of obligation, the higher the propensity to allocate risky assets in the portfolio. Meanwhile, individuals with higher risk tolerance, income and education levels show greater propensity to allocate risky assets in the portfolio.Research limitations/implicationsThe sample is restricted to Muslims in Kuala Lumpur; hence, the findings are not easily generalized to Muslim investors in general. Findings may differ between Muslims across the world, so future research needs to expand from a country specific to an international analysis. In addition, future studies could include other determinants of portfolio allocation, such as financial literacy.Practical implicationsThe findings of this study may assist financial planners and policymakers to better understand the drivers of portfolio allocation among their Muslim clients.Originality/valueWhile other studies have tended to focus on the impact of religiosity on the holdings of specific financial assets, such as Islamic bank accounts or Takaful, the present study explores the effect of Islamic religiosity dimensions on the allocations of risky assets in the portfolio. The study also develops an ordinal measure of portfolio allocation and makes a methodological contribution by using an ordered probit regression analysis.

Canner, Mankiw and Weil (1997) point out that the popular financial advisors on portfolio allocation among cash, bonds and stocks appear not to follow the mutual-fund separation theorem and call the inconsistency between separation theorem and popular financial advice ”an asset allocation puzzle.” For solving the asset allocation puzzle, we provide an analysis of the optimal dynamic asset allocation strategy for a long-horizon investor who has nontraded assets under an economic environment with stochastic investment opportunities and incomplete financial markets. We propose another distinguishing hedging component of the dynamic asset allocation for the stock index fund: the human capital hedging component, the hedging demand which characterizes the demand arising from the desire to hedge against changes in the labor income in contrast to Merton (1973). When we incorporate nontraded assets with intertemporal hedging, we can solve the asset allocation puzzle successfully.

Strategic Asset Allocation and Markov Regime Switch with GARCH Model

Behavioral biases of finance professionals: Turkish evidence

Contemporarily, as the economy enters the new normal, Chinese real estate prices that rose almost unilaterally in the past will be difficult to appear again. With just break, the high yield of wealth management products will no longer be the scene. Therefore, the importance of risk diversification among different assets, i.e., the allocation decision of major assets, becomes more and more prominent. This paper mainly investigates the application of principal component risk parity model in asset allocation. Specifically, the article focuses on the result of the experiment and the importance of this model. In the experiment, the principal component risk parity model is compared with the traditional risk parity model. At the same time, the principal component parity risk model is further analyzed and compared with other models from the related formulae derivation. Finally, the corresponding conclusions are drawn, and the advantages and necessity of rational usage of risk parity model in asset allocation are put forward. Overall, these results shed light on guiding further exploration of finding efficient models to help with asset allocation.