Optimal asset allocation using a combination of implied and historical information

Chi Wan Cheang, Jose Olmo, Tiejun Ma, Ming-Chien Sung, Frank McGroarty

Research output: Contribution to journalArticlepeer-review

Abstract / Description of output

This paper investigates the contribution of option-implied information for strategic asset allocation for individuals with minimum-variance preferences and portfolios with a variety of assets. We propose a covariance matrix that exploits a mixture of historical and option-implied information. Implied variance measures are proposed for those assets for which option-implied information is available. Historical variance and correlation measures are applied to the remaining assets. The performance of this novel approach for constructing optimal investment portfolios is assessed out-of-sample using statistical and economic measures. An empirical application to a sophisticated portfolio comprised by a combination of equities, fixed income, alternative securities and cash deposits shows that implied variance measures with risk premium correction outperform variance measures constructed from historical data and implied variance without correction. This result is robust across investment portfolios, volatility and portfolio performance metrics, and rebalancing schemes.
Original languageEnglish
Article number101419
Number of pages14
JournalInternational Review of Financial Analysis
Volume67
Early online date20 Nov 2019
DOIs
Publication statusPublished - 1 Jan 2020

Keywords / Materials (for Non-textual outputs)

  • Asset allocation
  • Implied volatility
  • Historical volatility
  • Realized variance
  • Sharpe ratio

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