Spillovers and Asset Allocation

Abstract

There is a large and growing literature on spillovers but no study that systematically evaluates the importance of spillovers for portfolio management. This paper provides such an analysis and demonstrates that spillovers are fully embedded in estimates of expected returns, variances, and correlations and that estimation of spillovers is not necessary for asset allocation. Simulations of typical empirical spillover settings further show that same-frequency spillovers are often negligible and spurious.

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“…Crucially, spillovers estimate the share of new information not fully priced into an asset. Hoang and Baur (2021) show that explicitly considering volatility and return spillovers is not necessary for asset allocation as spillovers are already incorporated in contemporaneous correlations of returns and volatility in the determination of optimal portfolio weights. In practice, however, spillovers are intuitive and important for portfolio managers to understand interdependencies and to identify the origin and impact of spillovers.…”