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Monetary Policy and Risk-Based Asset Allocation

Author

Listed:
  • Alexis Flageollet

    (NATIXIS Asset Management)

  • Hamza Bahaji

    (NATIXIS Asset Management
    University of Paris Dauphine)

Abstract

This paper focuses on the effects of the Fed’s monetary policy on stock and bond returns co-movement and their implications to risk-based asset allocation. Using a regime-switching model that controls for the economic effects of monetary policy we identify three co-movement regimes. We document that risk-based portfolio strategies poorly perform in the low correlation regime which features inflation shocks. We find outperformance evidence under the negative correlation regime with a high stock market risk and a very accommodating Fed policy. Less effectiveness is demonstrated under the positive correlation regime where bonds are regarded as risky assets and interest rate volatility is fueled by monetary policy.

Suggested Citation

  • Alexis Flageollet & Hamza Bahaji, 2016. "Monetary Policy and Risk-Based Asset Allocation," Open Economies Review, Springer, vol. 27(5), pages 851-870, November.
    • Handle: RePEc:kap:openec:v:27:y:2016:i:5:d:10.1007_s11079-016-9404-1
    DOI: 10.1007/s11079-016-9404-1
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    References listed on IDEAS

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    Cited by:

    1. Gokmenoglu, Korhan K. & Hadood, Abobaker Al.Al., 2020. "Impact of US unconventional monetary policy on dynamic stock-bond correlations: Portfolio rebalancing and signalling channel effects," Finance Research Letters, Elsevier, vol. 33(C).
    2. Gylych Jelilov & Bilal Celik & Yusuf Adamu, 2020. "Foreign Portfolio Investment Response to Monetary Policy Decisions in Nigeria: A Toda-Yamamoto Approach," International Business Research, Canadian Center of Science and Education, vol. 13(3), pages 166-166, March.

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    More about this item

    Keywords

    Monetary policy; Hidden Markov model; Co-movement; Minimum variance; Equal risk contribution;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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