Modeling and managing portfolios including listed private equity |
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Authors: | Philipp Aigner |
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Affiliation: | a University of Oxford, UK b HVB Institute for Mathematical Finance, TU München, Germany |
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Abstract: | Listed private equity (LPE) provides investors with a liquid means of considering private equity in their portfolios. This paper presents a first-order autoregressive Markov-switching model (ARMS) which is able to capture the characteristics of the asset classes bonds, stocks, and LPE, such as heavy tails and autocorrelation. Optimizing a portfolio between bonds, stocks, and LPE shows that an investor benefits from including LPE due to the high diversification effects, which also holds for a very risk-averse investor. Allocating a portfolio with the presented Markov-switching optimization can help to significantly outperform a portfolio which is optimized assuming an underlying geometric Brownian motion (GBM) - even during the financial crisis: The terminal value of a portfolio of a model investor with medium risk aversion was on average 8.7% higher over the three years 2007-2009 than the GBM portfolio. |
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Keywords: | Markov-switching models Private equity Listed private equity Asset allocation Portfolio optimization Financial crisis |
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