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How to fly to safety without overpaying for the ticket

Author

Listed:
  • Kaczmarek Tomasz

    (Department of Investment and Financial Markets, Institute of Finance, Poznań University of Economics and Business, al. Niepodległości 10, 61-875 Poznań, Poland)

  • Grobelny Przemysław

    (Department of Investment and Financial Markets, Institute of Finance, Poznań University of Economics and Business, al. Niepodległości 10, 61-875 Poznań, Poland)

Abstract

For most active investors treasury bonds (govs) provide diversification and thus reduce the risk of a portfolio. These features of govs become particularly desirable in times of elevated risk which materialize in the form of the flight-to-safety (FTS) phenomenon. The FTS for govs provides a shelter during market turbulence and is exceptionally beneficial for portfolio drawdown risk reduction. However, what if the unsatisfactory expected return from treasuries discourages higher bonds allocations? This research proposes a solution to this problem with Deep Target Volatility Equity-Bond Allocation (DTVEBA) that dynamically allocate portfolios between equity and treasuries. The strategy is driven by a state-of-the-art recurrent neural network (RNN) that predicts next-day market volatility. An analysis conducted over a twelve year out-of-sample period found that with DTVEBA an investor may reduce treasury allocation by two (three) times to get the same Sharpe (Calmar) ratio and overper-forms the S&P500 index by 43% (115%).

Suggested Citation

  • Kaczmarek Tomasz & Grobelny Przemysław, 2023. "How to fly to safety without overpaying for the ticket," Economics and Business Review, Sciendo, vol. 9(2), pages 160-183, April.
    • Handle: RePEc:vrs:ecobur:v:9:y:2023:i:2:p:160-183:n:2
    DOI: 10.18559/ebr.2023.2.738
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    More about this item

    Keywords

    asset allocation strategy; target volatility; flight-to-safety; recurrent neural networks; machine learning;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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