Dynamic Portfolio Selection: The Relevance of Switching Regimes and Investment Horizon

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Published in European Financial Management, 2003, vol. 9, 179-200.

Abstract: This paper investigates the questions of dynamic portfolio selection and intertemporal hedging within a Markovian regime-switching framework. The investment opportunity set is spanned by a well-diversified home-market portfolio and the risk-free asset. Our results highlight the economic importance of regimes, as optimal portfolio weights are clearly dependent on the prevailing regime. We present evidence that the question of intertemporal hedging is a more complex issue than is hinted in the previous literature, since demand for intertemporal hedging is present in some regimes, but not in others. Finally, our main findings are qualitatively unchanged across the four largest stock markets in the world.

Keywords: intertemporal hedging, dynamic portfolio selection, regime switching.