Article ID: | iaor20118142 |
Volume: | 39 |
Issue: | 4 |
Start Page Number: | 753 |
End Page Number: | 764 |
Publication Date: | Apr 2012 |
Journal: | Computers and Operations Research |
Authors: | Zagst Rudi, Aigner Philipp, Beyschlag Georg, Friederich Tim, Kalepky Markus |
Keywords: | markov processes, simulation: applications |
Listed private equity (LPE) provides investors with a liquid means of considering private equity in their portfolios. This paper presents a first‐order autoregressive Markov‐switching model (ARMS) which is able to capture the characteristics of the asset classes bonds, stocks, and LPE, such as heavy tails and autocorrelation. Optimizing a portfolio between bonds, stocks, and LPE shows that an investor benefits from including LPE due to the high diversification effects, which also holds for a very risk‐averse investor. Allocating a portfolio with the presented Markov‐switching optimization can help to significantly outperform a portfolio which is optimized assuming an underlying geometric Brownian motion (GBM) – even during the financial crisis: The terminal value of a portfolio of a model investor with medium risk aversion was on average 8.7% higher over the three years 2007–2009 than the GBM portfolio.