nep-rmg New Economics Papers
on Risk Management
Issue of 2006‒08‒12
two papers chosen by
Stan Miles
York University

  1. International Portfolio Diversification and Market Linkages in the presence of regime-switching volatility By Thomas Flavin; Ekaterini Panopoulou
  2. Subsampling-Based Tests of Stock-Return Predictability By In Choi; Timothy K. Chue

  1. By: Thomas Flavin; Ekaterini Panopoulou
    Abstract: We examine if the benefits of international portfolio diversification are robust to time-varying asset return volatility. Since diversified portfolios are subject to common cross-country shocks, we focus on the transmission mechanism of such shocks in the presence of regime-switching volatility. We find little evidence of increased market interdependence in turbulent periods. Furthermore, for the vast majority of time, we show that risk reduction is delivered for the US investor who holds foreign equity.
    Keywords: Market comovement; International portfolio diversification; Financial market crises; Regime switching.
    Date: 2006–08–02
  2. By: In Choi; Timothy K. Chue
    Abstract: We develop subsampling-based tests of stock-return predictability and apply them to U.S. data. These tests allow for multiple predictor variables with local-to-unit roots. By contrast, previous methods that model the predictor variables as nearly integrated are only applicable to univariate predictive regressions. Simulation results demonstrate that our subsampling-based tests have desirable size and power properties. Using stock-market valuation ratios and the risk-free rate as predictors, our univariate tests show that the evidence of predictability is more concentrated in the 1926-1994 subperiod. In bivariate tests, we find support for predictability in the full sample period 1926-2004 and the 1952-2004 subperiod as well. For the subperiod 1952-2004, we also consider a number of consumption-based variables as predictors for stock returns and find that they tend to perform better than the dividend-price ratio. Among the variables we consider, the predictive power of the consumption-wealth ratio proposed by Lettau and Ludvigson (2001a, 2001b) seems to be the most robust. Among variables based on habit persistence, Campbell and Cochrane's (1999) nonlinear specication tends to outperform a more traditional, linear specification.
    Keywords: Subsampling, local-to-unit roots, predictive regression, stock-return predictability, consumption-based models
    Date: 2006–07

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