Country-specific equity market characteristics and foreign equity portfolio allocation

Do country-specific equity market characteristics explain variations in foreign equity portfolio allocation? We study this question using comprehensive foreign equity portfolio holdings data and different measures of country-specific equity market factors for 36 host countries. Employing panel data econometric estimations, our investigation shows that foreign investors prefer to invest more in larger and highly visible developed markets which are more liquid, exhibit a higher degree of market efficiency and have lower trading costs. The findings imply that by improving the preconditions necessary for well-functioning capital markets, policymakers should be able to attract higher levels of foreign equity portfolio investments.     

Income hedging and portfolio decisions

We examine whether the decision to participate in the stock market and other related portfolio decisions are influenced by income hedging motives. Economic theory predicts that the market participation propensity should increase as the correlation between income growth and stock market returns decreases. Surprisingly, empirical studies find limited support for the income hedging motive. Using a rich, unique Dutch data set and the National Longitudinal Survey of the Youth (NLSY) from the United States, we show that when the income-return correlation is low, individuals exhibit a greater propensity to participate in the market and allocate a larger proportion of their wealth to risky assets. Even when the income risk is high, individuals exhibit a higher propensity to participate in the market when the hedging potential is high. These findings suggest that income hedging is an important determinant of stock market participation and asset allocation decisions.     

Nonparametric correlation models for portfolio allocation

This article proposes time-varying nonparametric and semiparametric estimators of the conditional cross-correlation matrix in the context of portfolio allocation. Simulations results show that the nonparametric and semiparametric models are best in DGPs with substantial variability or structural breaks in correlations. Only when correlations are constant does the parametric DCC model deliver the best outcome. The methodologies are illustrated by evaluating two interesting portfolios. The first portfolio consists of the equity sector SPDRs and the S&P 500, while the second one contains major currencies. Results show the nonparametric model generally dominates the others when evaluating in-sample. However, the semiparametric model is best for out-of-sample analysis.     

Global equity fund performance, portfolio concentration, and the fundamental law of active management

This paper investigates the relation between portfolio concentration and the performance of global equity funds. Concentrated funds with higher levels of tracking error display better performance than their more broadly diversified counterparts. We show that the observed relation between portfolio concentration and performance is mostly driven by the breadth of the underlying fund strategies; not just by fund managers’ willingness to take big bets. Our results indicate that when investors strive to select the best-performing funds, they should not only consider fund managers’ tracking-error levels. More important is that they take into account the extent to which fund managers carefully allocate their risk budget across multiple investment strategies and have concentrated holdings in multiple market segments simultaneously.     

Size matters: Optimal calibration of shrinkage estimators for portfolio selection

We carry out a comprehensive investigation of shrinkage estimators for asset allocation, and we find that size matters—the shrinkage intensity plays a significant role in the performance of the resulting estimated optimal portfolios. We study both portfolios computed from shrinkage estimators of the moments of asset returns (shrinkage moments), as well as shrinkage portfolios obtained by shrinking the portfolio weights directly. We make several contributions in this field. First, we propose two novel calibration criteria for the vector of means and the inverse covariance matrix. Second, for the covariance matrix we propose a novel calibration criterion that takes the condition number optimally into account. Third, for shrinkage portfolios we study two novel calibration criteria. Fourth, we propose a simple multivariate smoothed bootstrap approach to construct the optimal shrinkage intensity. Finally, we carry out an extensive out-of-sample analysis with simulated and empirical datasets, and we characterize the performance of the different shrinkage estimators for portfolio selection.     

Long-horizon event studies and event firm portfolio weights: Evidence from U.K. rights issues re-visited

Empirical results, in long-horizon event studies, are sensitive to whether equal- or value-weighting schemes are used to form event firm portfolios. In this paper we propose, as a first step, an evaluation of the economic value to investing in an equal-weighted and a value-weighted event firm portfolio prior to the event study. Using tests for mean-variance spanning we find in our data a significant improvement in an investor's investment opportunity set to investing in an equal-weighted portfolio. We then re-visit the long-run post-offer performance for rights issuers in the U.K. where we find, as in other studies, differences in both the magnitude and statistical significance of abnormal performance for value-weighted and equal-weighted event firm portfolios. We then use the results from our first step to provide an economic rationale for interpreting our results. A general conclusion we draw is that it may be useful to first ascertain, in long-horizon event studies, the economic value of portfolio weighting schemes as this can then provide some guidance to the use of a specific portfolio weighting scheme and thereby to interpretation of often conflicting results.     

Local institutional investors,information asymmetries,and equity returns

We examine the informational role of geographically proximate institutions in stock markets. We find that both the level of and change in local institutional ownership predict future stock returns, particularly for firms with high information asymmetry; in contrast, such predictive abilities are relatively weak for nonlocal institutional ownership. The local advantage is especially evident for local investment advisors, high local ownership institutions, and high local turnover institutions. We also find that the stocks that local institutional investors hold (trade) earn higher excess returns around future earnings announcements than those that nonlocal institutional investors hold (trade).     

Does international cross-listing improve the information environment

We investigate whether cross-listing in the U.S. affects the information environment for non-U.S. stocks. Our findings suggest cross-listing has an asymmetric impact on stock price informativeness around the world, as measured by firm-specific stock return variation. Cross-listing improves price informativeness for developed market firms. For firms in emerging markets, however, cross-listing decreases price informativeness. The added analyst coverage associated with cross-listing likely explains the findings in emerging markets, rather than changes in liquidity, ownership, or accounting quality. Our results indicate that the added analyst coverage fosters the production of marketwide information, rather than firm-specific information.     

Profitability of momentum strategies in international markets: The role of business cycle variables and behavioural biases

The paper investigates whether business cycle variables and behavioural biases can explain the profitability of momentum trading in three major European markets. Unlike previous studies, the paper nests both risk-based and behavioural-based variables in a two-stage model specification in an attempt to explain momentum profits. The findings show that, although momentum profitability in European markets is unexplained by conditional asset pricing models, it is attributable to asset mispricing that systematically varies with global business conditions. In addition, behavioural variables do not appear to matter much. Thus risk factors, which are undetected thus far and are largely attributable to the business cycle, could explain the momentum payoffs in European stock markets.     

Using industry momentum to improve portfolio performance

Minimum-variance portfolios, which ignore the mean and focus on the (co)variances of asset returns, outperform mean–variance approaches in out-of-sample tests. Despite these promising results, minimum-variance policies fail to deliver a superior performance compared with the simple 1/N rule. In this paper, we propose a parametric portfolio policy that uses industry return momentum to improve portfolio performance. Our portfolio policies outperform a broad selection of established portfolio strategies in terms of Sharpe ratio and certainty equivalent returns. The proposed policies are particularly suitable for investors because portfolio turnover is only moderately increased compared to standard minimum-variance portfolios.     

Global private information in international equity markets

This paper studies international equity markets when some investors have private information that is valuable for trading in many countries simultaneously. We use a dynamic model of equity trading to show that global private information helps explain US investors’ trading behavior and performance. In particular, the model predicts global return chasing (positive co-movement of US investors’ net purchases with returns in many countries) which we show to be present in the data. Return chasing in our model can be due to superior performance of US investors, not inferior knowledge or naive trend-following. We also show that trades due to private information are strongly correlated across countries. A common (global) factor accounts for about half their variation.     

Technical analysis: An asset allocation perspective on the use of moving averages

In this paper, we analyze the usefulness of technical analysis, specifically the widely employed moving average trading rule from an asset allocation perspective. We show that, when stock returns are predictable, technical analysis adds value to commonly used allocation rules that invest fixed proportions of wealth in stocks. When uncertainty exists about predictability, which is likely in practice, the fixed allocation rules combined with technical analysis can outperform the prior-dependent optimal learning rule when the prior is not too informative. Moreover, the technical trading rules are robust to model specification, and they tend to substantially outperform the model-based optimal trading strategies when the model governing the stock price is uncertain.     

Mutual fund trades and the value of contradictory private information

We investigate the performance of mutual funds that trade using private information. These funds are uniquely identified from a set of 2730 funds with 44,315 fund-periods between 1994 and 2005. We compare the alignment of fund trades with brokers’ recommendations, which we regard as “public information” in the universe of informed and uninformed mutual funds. Funds that systematically trade counter to the public information form a homogenous subset of the privately informed funds. By using private information that contradicts the public information, these funds exhibit a superior average performance. After we control for serial correlation in fund returns, we assess this advantage as being an economically significant 1.7% per annum. We also show empirically that smaller funds are better able to capture the benefit of private information.     

The wisdom of crowds: Mutual fund investors’ aggregate asset allocation decisions

We find that the aggregate asset allocation decisions of US mutual fund investors depend on economic conditions. Both anticipated economic downturns and periods of turmoil lead investors to direct flow away from risky equity funds and towards lower-risk money market funds. These patterns are markedly stronger for investors in low cost and low turnover funds relative to investors in high cost and high turnover funds, consistent with sophisticated investors being more sensitive to changing conditions. Benchmarked against a buy-and-hold strategy, these asset allocation strategies reduce risk without degrading the risk-return trade-off. Our evidence suggests that individual investors, often dismissed as noise traders, collectively react to economic signals in a sensible manner when determining asset allocations.     

Household portfolio choices,health status and health care systems: A cross-country analysis based on SHARE

Health risk is increasingly viewed as an important form of background risk that affects household portfolio decisions. However, its role might be mediated by the presence of a protective full-coverage national health service that could reduce households’ probability of incurring current and future out-of-pocket medical expenditures. We use SHARE data to study the influence of current health status and future health risk on the decision to hold risky assets, across ten European countries with different health systems, each offering a different degree of protection against out-of-pocket medical expenditures. We find robust empirical evidence that perceived health status matters more than objective health status and, consistent with the theory of background risk, health risk affects portfolio choices only in countries with less protective health care systems. Furthermore, portfolio decisions consistent with background risk models are observed only with respect to middle-aged and highly-educated investors.     

Dynamic hedge fund portfolio construction: A semi-parametric approach

In this article, we evaluate alternative optimization frameworks for constructing portfolios of hedge funds. We compare the standard mean–variance optimization model with models based on CVaR, CDaR and Omega, for both conservative and aggressive hedge fund investment strategies. In order to implement the CVaR, CDaR and Omega optimization models, we propose a semi-parametric methodology, which is based on extreme value theory, copula and Monte Carlo simulation. We compare the semi-parametric approach with the standard, non-parametric approach, used to compute CVaR, CDaR and Omega, and the benchmark parametric approach, based on both static and dynamic mean–variance optimization. We report two main findings. The first is that the CVaR, CDaR and Omega models offer a significant improvement in terms of risk-adjusted portfolio performance over the parametric mean–variance model. The second is that semi-parametric estimation of the CVaR, CDaR and Omega models offers a very substantial improvement over non-parametric estimation. Our results are robust to the choice of target return, risk limit and estimation sample size.     

Implied volatility and future portfolio returns

Prior studies find that the CBOE volatility index (VIX) predicts returns on stock market indices, suggesting implied volatilities measured by VIX are a risk factor affecting security returns or an indicator of market inefficiency. We extend prior work in three important ways. First, we investigate the relationship between future returns and current implied volatility levels and innovations. Second, we examine portfolios sorted on book-to-market equity, size, and beta. Third, we control for the four Fama and French [Fama, E., French, K., 1993. Common risk factors in the returns on stocks and bonds. Journal of Financial Economics 33, 3–56.] and Carhart [Carhart, M., 1997. On persistence in mutual fund performance. Journal of Finance, 52, 57–82.] factors. We find that VIX-related variables have strong predictive ability.     

Access to management and the informativeness of analyst research

We examine whether access to management at broker-hosted investor conferences leads to more informative research by analysts. We find analyst recommendation changes have larger immediate price impacts when the analyst?s firm has a conference-hosting relation with the company. The effect increases with hosting frequency and is strongest in the days following the conference. Conference-hosting brokers also issue more informative, accurate, and timely earnings forecasts than non-hosts. Our findings suggest that access to management remains an important source of analysts? informational advantage in the post-Regulation Fair Disclosure world.     

International portfolio selection with exchange rate risk: A behavioural portfolio theory perspective

This paper analyzes international portfolio selection with exchange rate risk based on behavioural portfolio theory (BPT). We characterize the conditions under which the BPT problem with a single foreign market has an optimal solution, and show that the optimal portfolio contains the traditional mean–variance efficient portfolio without consideration of exchange rate risk, and an uncorrelated component constructed to hedge against exchange rate risk. We illustrate that the optimal portfolio must be mean–variance efficient with exchange rate risk, while the same is not true from the perspective of local investors unless certain conditions are satisfied. We further establish that international portfolio selection in the BPT with multiple foreign markets consists of two sequential decisions. Investors first select the optimal BPT portfolio in each market, overlooking covariances among markets, and then allocate funds across markets according to a specific rule to achieve mean–variance efficiency or to minimize the loss in efficiency.     

Mutual fund portfolio trading and investor flow

I estimate the extent to which mutual fund portfolio trading of securities is triggered by investor flows into and out of the funds, and find that this liquidity-induced portfolio trading activity is smaller than previously estimated by Edelen (1999). I obtain estimates from a much larger and broader sample of funds than Edelen’s (1999) sample. Portfolio managers of international funds trade a smaller fraction of investor flow than do those of domestic funds. Index funds invest a larger fraction. A funds’ usage of futures contracts does not have a statistically significant effect on how it trades in response to investor flows, but the unpredictability of investor flow weakly affects the trading response to flow.