International asset allocation using the market implied cost of capital

International asset allocation using the market implied cost of capital The Black and Litterman (Financ Anal J 48(5):28–43, 1992) (BL) approach to portfolio optimization requires investor views on expected asset returns as an input. I demonstrate that the market implied cost of capital (ICC) is ideal for quantifying those views on a country level. I benchmark this approach against a BL optimization using time-series models as investor views, the equally weighted portfolio, and allocation methods based on stock market capitalization and GDP. I find that the ICC portfolio offers an increase in average return of 2.1 percentage points (yearly) as compared to the value-weighted portfolio, while having a similar standard deviation. The resulting difference in Sharpe ratios is statistically significant and robust to the inclusion of transaction costs, varying BL parameters, and a less strictly defined investment universe. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Financial Markets and Portfolio Management Springer Journals

International asset allocation using the market implied cost of capital

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Publisher
Springer US
Copyright
Copyright © 2017 by Swiss Society for Financial Market Research
Subject
Business and Management; Business and Management, general; Finance, general; Management
ISSN
1934-4554
eISSN
2373-8529
D.O.I.
10.1007/s11408-017-0302-3
Publisher site
See Article on Publisher Site

Abstract

The Black and Litterman (Financ Anal J 48(5):28–43, 1992) (BL) approach to portfolio optimization requires investor views on expected asset returns as an input. I demonstrate that the market implied cost of capital (ICC) is ideal for quantifying those views on a country level. I benchmark this approach against a BL optimization using time-series models as investor views, the equally weighted portfolio, and allocation methods based on stock market capitalization and GDP. I find that the ICC portfolio offers an increase in average return of 2.1 percentage points (yearly) as compared to the value-weighted portfolio, while having a similar standard deviation. The resulting difference in Sharpe ratios is statistically significant and robust to the inclusion of transaction costs, varying BL parameters, and a less strictly defined investment universe.

Journal

Financial Markets and Portfolio ManagementSpringer Journals

Published: Nov 27, 2017

References

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