INTERNATIONAL ASSET ALLOCATION WITH TIME-VARYING INVESTMENT OPPORTUNITIES

DISCUSSION PAPER SERIES

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Available online at:https://www.doczj.com/doc/b82762253.html,/pubs/dps/DP3464.asp

No. 3464

INTERNATIONAL ASSET

ALLOCATION WITH TIME-VARYING

INVESTMENT OPPORTUNITIES

Allan G Timmermann and David Blake

FINANCIAL ECONOMICS

ISSN 0265-8003 INTERNATIONAL ASSET

ALLOCATION WITH TIME-VARYING

INVESTMENT OPPORTUNITIES

Allan G Timmermann, University of California, San Diego and CEPR

David Blake, Birkbeck College, London

Discussion Paper No. 3464

July 2002

Centre for Economic Policy Research

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This Discussion Paper is issued under the auspices of the Centre’s research programme in FINANCIAL ECONOMICS. Any opinions expressed here are those of the author(s) and not those of the Centre for Economic Policy Research. Research disseminated by CEPR may include views on policy, but

the Centre itself takes no institutional policy positions.

The Centre for Economic Policy Research was established in 1983 as a private educational charity, to promote independent analysis and public discussion of open economies and the relations among them. It is pluralist

and non-partisan, bringing economic research to bear on the analysis of medium- and long-run policy questions. Institutional (core) finance for the Centre has been provided through major grants from the Economic and Social Research Council, under which an ESRC Resource Centre operates within CEPR; the Esmée Fairbairn Charitable Trust; and the Bank of England. These organizations do not give prior review to the Centre’s publications, nor do they necessarily endorse the views expressed therein.

These Discussion Papers often represent preliminary or incomplete work, circulated to encourage discussion and comment. Citation and use of such a paper should take account of its provisional character.

Copyright: Allan G Timmermann and David Blake

CEPR Discussion Paper No. 3464

July 2002

ABSTRACT

International Asset Allocation with

Time-Varying Investment Opportunities*

This Paper analyses the international equity holdings of a large panel of UK pension funds. We find considerable evidence of market timing activity, as illustrated by the funds’ decision to scale back their investments in the US stock market during the 1990s. To explain this we model portfolio weight dynamics as a function of time-varying conditional moments. We find that a substantial part of the evolution in portfolio weights is explained by time-varying conditional expected returns, volatilities and covariances with domestic equity returns. Consequently, controlling for the effect of state variables that track time-variations in investment opportunities significantly affects estimates of returns from international market timing. Our estimates suggest that the portfolio movements that were orthogonal to such state variables accounted for a net loss of 0.2% per annum for the average fund. JEL Classification: G10

Keywords: international asset allocation, investment performance, market timing and UK pension funds

Allan G Timmermann

UCSD Department of Economics 9500 Gilman Drive

La Jolla

CA 92093-0508

USA

Tel: (1 858) 534 4860

Fax: (1 858) 534 7040

Email: atimmerm@https://www.doczj.com/doc/b82762253.html,

For further Discussion Papers by this author see: https://www.doczj.com/doc/b82762253.html,/pubs/new-dps/dplist.asp?authorid=116464David Blake

Pensions Institute

Birkbeck College

Gresse Street

LONDON

W1P 2LL

Tel: (44 20) 7631 6410

Fax: (44 20) 7631 6416

Email: dblake@https://www.doczj.com/doc/b82762253.html,

For further Discussion Papers by this author see: https://www.doczj.com/doc/b82762253.html,/pubs/new-dps/dplist.asp?authorid=106126

*BSI Gamma Foundation are gratefully acknowledged for financial support. The comments of an anonymous referee were very helpful in revising the Paper. We would also like to thank Val Ashmore, Alistair MacDougall and Alan Puride of The WM Company and Hedi Dorai of Morgan Stanley Capital International for their help in providing us with the data set used in this study. Mike Brennan provided many suggestions that greatly improved the Paper. We also thank Alastair Ross Goobey, CEO of Hermes Pension Fund Managers, Graham Elliott, Michael Melvin and seminar participants at University of Cambridge, City University Business School, Imperial College Management School, London School of Economics, and the 1999 London conference on Forecasting in Financial Markets for helpful suggestions. Submitted 03 July 2002

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