On the usefulness of dynamically spilled risk: An optimal portfolio allocation based on cross-sector information contagion

Abstract

It is well known that the volatility spillover increases when a large economic shock occurs, and then the volatility spillover pattern in the market changes. Accordingly, many papers note that clarifying the time-varying pattern of volatility transmission in domestic and international markets is useful for investors and policymakers. This paper focuses on information contagion across various industrial sectors, investigates portfolio strategies based on the volatility spillovers, and aims to clarify whether an investment strategy based on volatility spillovers benefits investors. Regarding portfolio reallocation, as soon as we observe an increase or a decrease in the effect/timing of a volatility spillover, we obtain a smaller number of reallocations and a more informative portfolio. Our results compare our proposed method with periodic portfolios, for example, daily or annually, showing that our proposed method has larger returns and a greater Sharpe ratio than the others.

Keywords:

• portfolio management
• realized volatility
• VAR model
• volatility spillover
• cross-sector information contagion

Disclosure statement

No potential conflict of interest was reported by the author(s). The views expressed in this paper are those of the authors and do not necessarily reflect the official views of Nomura Holdings or Kwansei Gakuin University.

Notes

1. The TOPIX-17 series is a stock price index that reorganizes the TOPIX (traditionally used to classify Japanese stocks) into 17 industries for investment convenience.

2. MFE Toolbox: https://www.kevinsheppard.com/MFE_Toolbox

3. Since results depend on the lower bound of a short position, we do not consider the mean-variance portfolio with a short position.

4. See https://www.investopedia.com/terms/s/sector-etf.asp.

Additional information

Funding

This study is partly supported by the Institute of Statistical Mathematics (ISM) cooperative research program [2022-ISMCRP-2024], JSPS KAKENHI [Grant Number 21K01433], and Grant-in-Aid for JSPS Fellows [Grant Number 22J10285].