Navigating extreme market fluctuations: asset allocation strategies in developed vs. emerging economies.

Bonga-Bonga, Lumengo and Montshioa, Keitumetse (2024): Navigating extreme market fluctuations: asset allocation strategies in developed vs. emerging economies.

Abstract

This paper contributes to the literature on portfolio allocation by assessing how assets from emerging and developed stock markets can be allocated efficiently during crisis periods. Towards this end, the paper proposes an approach to portfolio allocation that combines traditional portfolio theory with extreme value theory (EVT) based on Generalised Pareto Distributions (GPDs) and Generalised Extreme Values (GEVs). The results of the empirical analysis show that for the mean-variance portfolio constructed from GPD, the emerging market portfolio outperforms both the international portfolio, the combination of emerging and developed market assets, and the developed market portfolio. However, the developed market portfolio outperforms the emerging market portfolio for the mean-variance portfolio constructed from GEV distribution. The paper attributes these different outcomes to the intended objectives of these extreme-value approaches in the context of portfolio selection. These results offer essential guidance for investors and asset managers during the construction of portfolios in times of crisis. They highlight that the effectiveness of a portfolio is significantly influenced by its predefined objectives. Ultimately, these objectives are crucial in deciding the most suitable approach for portfolio construction.

• Item Type: MPRA Paper
• Language: English
• Keywords: Extreme Value Theory; General Pareto Distribution; Emerging and developed markets; portfolio optimisation; mean-variance.
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

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