Asset strongAllocationstrong in a Value-at-Risk Framework.pdfVIP

Asset Allocation in a Value-at-Risk Framework Ronald Huisman, Kees G. Koedijk and Rachel A.J. Pownall April 1999 In this paper we develop an asset allocation model which allocates assets by maximising expected return subject to the constraint that the expected maximum loss should meet the Value-at-Risk limits set by the risk manager. Similar to the mean-variance approach a performance index like the Sharpe index is constructed. Furthermore it is shown that the model nests the mean-variance approach in case of normally distributed expected returns. We provide an empirical analysis using two assets: US stocks and bonds. The results highlight the influence of non-normal characteristics of the expected return distribution on the optimal asset allocation. Correspondence: Rachel A. J. Pownall Erasmus University Rotterdam, Faculty of Business Administration Financial Management, 3000 DR Rotterdam The Netherlands Tel: +31 10 4081255 Fax: +31 10 4089017 All authors are at the Erasmus University in Rotterdam. Koedijk is also at Maastricht University, and CEPR. The respective email addresses are rhuisman@fac.fbk.eur.nl, ckoedijk@fac.fbk.eur.nl, and rpownall@fac.fbk.eur.nl. All errors pertain to the authors. The authors would like to thank Frans de Rhoon and participants at the Rotterdam Institute for Financial Management lunch seminar series for their comments. 1 Introduction Modern portfolio theory aims to allocate assets by maximising the expected risk premium per unit of risk. In a mean-variance framework risk is defined in terms of the possible variation of expected portfolio returns. The focus on standard deviation as the appropriate measure for risk implies