Asset Allocation with a High Dimensional Latent Factor Stochastic Volatility Model

Yufeng Han

230 citations0/0 files storedReview of Financial Studies

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Financial Risk and Volatility Modeling Stochastic processes and financial applications Risk and Portfolio Optimization

Abstract

We investigate the implications of time-varying expected return and volatility on asset allocation in a high-dimensional setting. We propose a DFMSV model that allows the first two moments of returns to vary over time for a large number of assets. We then evaluate the economic significance of the DFMSV model by examining the performance of various dynamic portfolio strategies chosen by mean-variance investors in a universe of 36 stocks. We find that the DFMSV dynamic strategies significantly outperform various benchmark strategies out of sample. This outperformance is robust to different performance measures, investor's objective functions, time periods, and assets.

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References

2002No Contagion, Only Interdependence: Measuring Stock Market Comovements 1998Stochastic Volatility: Likelihood Inference and Comparison with ARCH Models 2001Consumption, Aggregate Wealth, and Expected Stock Returns 2000Investing for the Long Run when Returns Are Predictable 19965 Stochastic volatility 1995Predictability of Stock Returns: Robustness and Economic Significance 1999No Contagion, Only Interdependence: Measuring Stock Market Co-movements 1994Chapter 49 Arch models

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