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RFS Advance Access originally published online on February 20, 2008
Review of Financial Studies 2008 21(2):889-935; doi:10.1093/rfs/hhn006
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© The Author 2008. Published by Oxford University Press on behalf of the Society for Financial Studies. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org.

International asset allocation under regime switching, skew, and kurtosis preferences

Massimo Guidolin
Manchester Business School and Federal Reserve Bank of St. Louis

Allan Timmermann
University of California, San Diego, and CREATES

Address correspondence to Massimo Guidolin, University of Manchester, ManchesterBusiness School, MBS Crawford House, Booth Street East, Manchester M13 9PL, UK; telephone: +44-(0)161-306-6406; fax: +44-(0)161-275-4023; e-mail: Massimo.Guidolin{at}mbs.ac.uk

JEL: G12, F30, C32


  Abstract

This paper investigates the international asset allocation effects of time-variations in higher-order moments of stock returns such as skewness and kurtosis. In the context of a four-moment International Capital Asset Pricing Model (ICAPM) specification that relates stock returns in five regions to returns on a global market portfolio and allows for time-varying prices of covariance, co-skewness, and co-kurtosis risk, we find evidence of distinct bull and bear regimes. Ignoring such regimes, an unhedged US investor's optimal portfolio is strongly diversified internationally. The presence of regimes in the return distribution leads to a substantial increase in the investor's optimal holdings of US stocks, as does the introduction of skewness and kurtosis preferences.

We thank the editor, Cam Harvey, and an anonymous referee for making many valuable suggestions. We also thank Karim Abadir, Ines Chaieb, Charles Engel (a discussant), Serguey Sarkissian (a discussant), Lucio Sarno, Fabio Trojani, Giorgio Valente, and Mike Wickens, as well as seminar participants at Catholic University Milan, Collegio Carlo Alberto Foundation in Turin, European Financial Management Annual Conference in Milan (July 2005), HEC Paris and the Hong Kong Monetary Authority Conference on "International Financial Markets and the Macroeconomy" (July 2006). Imperial College Tanaka Business School, Krannert School of Management at Purdue, Manchester Business School, University of Lund, University of Washington, University of York (UK), the Third Biennial McGill Conference on Global Asset Management (June 2007), Warwick Business School, and the World Congress of the Econometric Society in London also provided helpful comments. All errors remain our own. Allan Timmermann acknowledges research support from CREATES, funded by the Danish National Research Foundation.


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