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Strategic Asset Allocation Under a Fractional Hidden Markov Model |
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| Authors: | Robert J Elliott Tak Kuen Siu |
| Institution: | 1. School of Mathematical Sciences, University of Adelaide, SA, 5005, Adelaide, Australia 2. Haskayne School of Business, University of Calgary, Calgary, Alberta, Canada 3. Centre for Applied Financial Studies, University of South Australia, Adelaide, Australia 4. Cass Business School, City University London, 106 Bunhill Row, London, EC1Y 8TZ, UK 5. Department of Applied Finance and Actuarial Studies, Faculty of Business and Economics, Macquarie University, Sydney, Australia |
| Abstract: | Strategic asset allocation is discussed in a discrete-time economy, where the rates of return from asset classes are explained in terms of some observable and hidden factors. We extend the existing models by incorporating long-term memory in the rates of return and observable economic factors, which have been documented in the empirical literature. Hidden factors are described by a discrete-time, finite-state, hidden Markov chain noisily observed in a fractional Gaussian process. The strategic asset allocation problem is discussed in a mean-variance utility framework. Filtering and parameter estimation are also considered in the hybrid model. |
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