Authors propose regime-based strategic asset allocation by modeling economic regimes as mixtures of distributions. The approach builds robust portfolios using macro regime information, often outperforming traditional asset-based methods.
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Abstract
We address the question of strategic asset allocation in the presence of economic regimes. Modeling regimes as a mixture of distributions, we investigate the implications for portfolios built under popular asset allocation methodologies (mean-variance optimization, risk budgeting). Using these analytical results, we define new portfolio construction methodologies that exploit the information in macroeconomic (macro) regimes through the composition of optimal portfolios for each regime, the risk structure of these portfolios, and the long-term probability of the regimes. Our findings have practical implications, as we empirically show that macro regime-based portfolios can outperform traditional asset-based portfolios.