Asset allocation in extreme market conditions: a comparative analysis between developed and emerging economies

This study makes use of the Extreme Value Theory, based on the Generalised Pareto Distribution and the Generalised Extreme Value Distribution, to construct efficient portfolios during periods of turmoil. The portfolios are constructed by combining different assets constituted by their positions in emerging and developed stock markets, with the aim of identifying which assets combinations provide optimal portfolio allocations during turmoil periods. For the developed stock markets, the study uses the French CAC 40, the Canadian S&P/TSX, the United Kingdom FTSE 100, the Japanese NIKKEI 225 and the United States S&P500 indices and returns. Five emerging stock markets indices are used, namely, the Brazilian BOVESPA, the Chinese SHCOMP the Indian S&P BSE SENEX, Indonesian JSI and the Turkish BIST 100. The data sample spans from August 1997 to August 2019 and include major economic and financial crises. Our findings show that for the different portfolios constructed, the estimated shape, location, and scale parameters differ depending on the Extreme Value Theory distribution under investigation. Moreover, based on the Generalised Pareto Distribution and the Generalised Extreme Value Distribution for portfolio optimisation, the results of the study show that during extreme conditions investors are prone to allocate more weight to developed stock market assets than to emerging markets. This confirms that developed economies are safe havens, especially during extreme market conditions. Moreover, the GPD is superior as it provides maximum risk-reward ratios.