Market timing under multiple economic regimes

Abstract

This article models the US equity premium as a regime-switching process where the regimes are dependent on economic variables. To characterise the economic regimes, we employ the dimension reduction technique of a principal components analysis to extract business cycle signals from a set of observed macroeconomic variables. We use these conditioning agents to infer the ex ante economic regime. We then test a dynamic asset allocation strategy, which invests in equity and cash on the basis of the predicted regimes. This timing strategy is shown to outperform a simple buy and hold strategy on a risk-adjusted basis.

Active asset allocation for retirement funds using the fed model

“…The literature on timing continues to grow with new and more complex trading rules based on fundamentals (Feldman, Jung, & Klein, 2015), macroeconomic variables (Breen, Glosten, &Jagamathan, 1989 andGuido, Peral, &Walsh, 2011), nonfinancial indicators (Krueger & Kennedy, 1990), mean reversion (Campbell, Andrew, & McKinley, 1999), and technical indicators (Lo, Mamaysky, & Wang, 2000). Critics of these studies point to problems of transaction costs, tax effects, and data mining (Aronson, 2006;Asness, 2003;and Sullivan, Timmerman, & White, 1999).…”