A1564
Title: Properties of the Margrabe best-of-two strategy to tactical asset allocation
Authors: Giang Nguyen - Vrije Universiteit Brussel (Belgium) [presenting]
David Ardia - HEC Montréal (Canada)
Kris Boudt - Vrije Universiteit Brussel and VU Amsterdam (Belgium)
Stefan Hartmann - Finvex (Belgium)
Abstract: The Margrabe Best-of-two strategy is a rule-based dynamic investment solution for the two-asset allocation problem. Its typical implementation involves yearly rebalancing the portfolio weights to 50-50 between a high-risk and low-risk asset. It uses intra-year weight adjustments to chase the momentum of the best performing asset by replicating the value of a Margrabe option to exchange an asset for another. In practice, this means that the Margrabe portfolio allocation benefits from the upside potential of the high-risk asset and the downside protection from the low-risk asset. The strategy depends on the assets prices, their return volatilities and correlation as well as the remaining time until year-end. We derive analytical formulae and use simulations to provide insights on the sensitivity of the strategy's weights and performance to these input parameters. We also report the results of an extensive out-of-sample evaluation for the bond-equity investment problem, where we compare the strategy with alternative solutions.
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