Rebonato, Riccardo and Denev, Alexander (2011): Coherent Asset Allocation and Diversification in the Presence of Stress Events.
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We propose a method to integrate frequentist and subjective probabilities in order to obtain a coherent asset allocation in the presence of stress events. Our working assumption is that in normal market asset returns are sufficiently regular for frequentist statistical techniques to identify their joint distribution, once the outliers have been removed from the data set. We also argue, however, that the exceptional events facing the portfolio manager at any point in time are specific to the each individual crisis, and that past regularities cannot be relied upon. We therefore deal with exceptional returns by eliciting subjective probabilities, and by employing the Bayesian net technology to ensure logical consistency. The portfolio allocation is then obtained by utility maximization over the combined (normal plus exceptional) distribution of returns. We show the procedure in detail in a stylized case.
|Item Type:||MPRA Paper|
|Original Title:||Coherent Asset Allocation and Diversification in the Presence of Stress Events|
|Keywords:||Stress tests, asset allocation, Bayesian Networks|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions|
|Depositing User:||Alexander Denev|
|Date Deposited:||02. May 2011 01:19|
|Last Modified:||15. Feb 2013 21:22|
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