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A Four-moment Portfolio Strategy for Emerging Equity Markets

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The research investigates an alternative prescriptive portfolio strategy to the conventional mean-variance (MV) approach, with application to emerging equity markets. Such markets deserve attention and empirical investigation due to the evolving nature of their distinctive returns characteristics, notably significant skewness and kurtosis. The portfolio problem is built around expected utility maximisation (EUM) framework. A four-moment (4M) approximation to the EUM – which takes into account the third and fourth moments of the portfolio returns – is proposed, and evaluated. Employing MSCI equity market indices from January 2002 to May 2008, the empirical results show that use of MV instead of 4M portfolio weights could incur significant certainty equivalent loss, especially when the level of risk aversion is high. The result also highlights the role of emerging markets in international diversification. [Hereafter, work in progress] Simulations are employed to examine the 4M strategy’s robustness to estimation error, in the same spirit as Chopra and Ziemba (1993). The positive simulation result would confirm the superiority of 4M over MV.

This talk is part of the Cambridge Finance Workshop Series series.

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